The Tax Code: A Playground for the Few, A Labyrinth for the Many

Each year, Americans pay tax preparers billions of dollars to file our taxes. Though 70 percent of us qualify to file our taxes for free, few of us do. Part of the reason is that the tax code has become so convoluted, and the ramifications of erring so onerous, that tax preparers have become almost a priestly class of intercessors between the IRS and taxpayers. We dare not risk the wrath of the IRS by approaching it without an advocate.

And yet, most of us are simply reporting numbers that the IRS already has. How do we know? Because if we report the numbers incorrectly, the IRS will tell us so. For many of us, filing our taxes is not about reporting our incomes so much as providing the IRS with free secretarial support.

While a dangerous pain to taxpayers, the cesspool of confusion, inefficiency, and manipulation that is the federal tax code won’t be simplified, because the code delivers a cornucopia of benefits to lawyers, tax accountants, favored industries, lobbyists, and politicians.

The benefits to lawyers and tax preparation services are obvious. The IRS estimates that the average taxpayer spends $240 just to file his federal tax return. For 158 million federal tax returns, the annual cost of complying with our byzantine code approaches $40 billion. But in most cases, the tax code is a make-work program. Congress digs legal holes, and we pay lawyers and accountants billions of dollars annually to fill them back in again.

Favored industries and lobbyists benefit more subtly. The more intricate the tax code, the easier it is for politicians to hand out favors to their preferred groups without attracting attention. Granting special tax treatment to a favored industry is as simple as hiding a needle composed of a few choice sentences in a 70,000-page haystack. Industries pay lobbyists to encourage politicians to hide these needles away from public view, and the politicians receive political and financial support from the industries in return. This symbiotic relationship among favored industries, lobbyists, and politicians thrives in an environment of complexity.

Meanwhile, complexity benefits the politicians both coming and going. While politicians receive support from industries by hiding gifts in the tax code, come election season, politicians decry the tax code and promise voters they’ll fight the complexity on the voters’ behalf. Politicians vilify corporations, promising to close tax “loopholes” that benefit the rich and powerful, while counting on voters not to notice that those same politicians created the loopholes in the first place. Politicians pledge to tax corporations, while counting on voters not to notice that every tax on a corporation gets passed on to voters in the form of higher prices, lower wages, or lesser returns. Politicians vow to make the rich pay their fair share, while counting on voters not to notice that the richest 10 percent of taxpayers already pay almost 75 percent of all federal income taxes. 

Politicians create the problem of a complex tax code and then present themselves to voters as its solution.

The real solution is simplification. A straightforward, easily understood tax code would reduce lobbyists’ and industries’ influence by making it more difficult for politicians to hand out special favors without the public noticing. Simplification would save taxpayers billions in time and money, and would allow the IRS to focus its resources on collecting dollars rather than collecting paperwork.

Interestingly, history provides a suggestion for straightforward simplification in what economists know, informally, as “Hauser’s Law.” It turns out that, for the past seventy years, it hasn’t mattered whether Congress taxed the rich or the poor, whether it taxed corporations or individuals, whether it taxed capital gains or wages, whether it taxed a lot or a little. The result has always been the same: The federal government has collected around 18 percent (plus or minus 2 percent) of the economy in tax revenue.

Data source: Federal Reserve Bank of St. Louis.

If 18 percent is the answer, regardless of the simplicity or complexity, let’s opt for simplicity and tax all income at 18 percent — no deductions, no exemptions, no credits, no caps, no different treatments for wages and capital gains.

The problem is that, even if politicians, lobbyists, lawyers, and tax accountants were in favor, we’d still end up with a complex tax code. Why? Because we all want a simplified tax code with the exception of our favorite carve-outs. Homeowners will say it’s not fair that they can’t deduct mortgage interest. Investors will say it’s not fair that capital gains should be taxed the same as wages. Those with chronic medical conditions will say that it’s not fair to lose their medical-expense deductions. The poor and middle classes will say that it’s not fair for them to pay the same tax rate as the rich.

While few benefit from a complex tax code as much as do politicians and those in political orbits, we each benefit a little bit in many different, small ways. Keep each of those different, small ways and we’re back to a complex tax code.

Alternatively, replacing the federal income tax with a national sales tax would shift the tax burden to consumption rather than income. When we grow angry about what we believe the rich should pay, we tend to picture the idle rich, living a high life off of passive income. What we don’t picture are hard-working middle-class people who have amassed wealth through perseverance and frugal living. An income tax hits the frugal and industrious. A consumption tax hits the idle spendthrifts. The major hurdle here is that a national sales tax would likely require a constitutional amendment. And, if we didn’t simultaneously repeal the 16th Amendment, which established the income tax, we’d end up with both a national sales tax and an income tax. A consumption-based tax would be more visible to consumers, as they would see the tax applied every time they purchased something. This would make it more difficult for politicians to hide tax favors and more difficult to sneak in tax increases.

The tax code’s complexity has created an environment in which tax-preparation services, lobbyists, favored industries, and politicians thrive, while taxpayers struggle to make sense of ever-changing rules and regulations. A reformed tax system would not only save taxpayers time, money, and frustration, but would also reduce opportunities for the powerful to co-opt the tax code to their benefit. Businesses would focus more on growth and innovation, instead of on co-opting a labyrinthine tax code. Entrepreneurs would focus more on attracting consumers rather than attracting politicians. Politicians would focus more on satisfying constituents rather than satisfying lobbyists. Lobbyists would find less demand for their services, and the many smart people who serve as tax lawyers and tax accountants would redirect their efforts to creating value, rather than counteracting problems Congress creates for the rest of us.

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