The IRS's National Taxpayer Advocate Nina E. Olson released her 2012 annual report to Congress on Wednesday, identifying the need for tax reform as the overriding priority in tax administration.
The Advocate also expressed concern that the Internal Revenue Service is not adequately funded to serve taxpayers and collect tax, and identified ways in which this chronic underfunding harms taxpayers and the public fisc. She also found that the IRS is not doing enough to assist victims of tax-related identity theft and return preparer fraud.
The National Taxpayer Advocate’s annual report designates the complexity of the tax code as the #1 most serious problem facing taxpayers and recommends that Congress take significant steps to simplify it. “The existing tax code makes compliance difficult, requiring taxpayers to devote excessive time to preparing and filing their returns,” Olson wrote. “It obscures comprehension, leaving many taxpayers unaware how their taxes are computed and what rate of tax they pay; it facilitates tax avoidance by enabling sophisticated taxpayers to reduce their tax liabilities and provides criminals with opportunities to commit tax fraud; and it undermines trust in the system by creating an impression that many taxpayers are not compliant, thereby reducing the incentives that honest taxpayers feel to comply.”
Compliance Burdens. The report states that the tax code imposes a “significant, even unconscionable, burden on taxpayers.” Since 2001, Congress has made nearly 5,000 changes to the tax code, an average of more than one a day, and the number of words in the code appears to have reached nearly four million.
An analysis of IRS data by the Taxpayer Advocate Service (TAS) shows that individuals and businesses spend about 6.1 billion hours a year complying with tax-filing requirements. “If tax compliance were an industry, it would be one of the largest in the United States,” the report says. “To consume 6.1 billion hours, the ‘tax industry’ requires the equivalent of more than three million full-time workers.”
Individual taxpayers find return preparation so overwhelming that few do it on their own. Nearly 60 percent of taxpayers hire paid preparers, and another 30 percent rely on commercial software, with leading software packages costing $50 or more. In other words, taxpayers must spend money just to figure out how much money they owe.
Magnitude of “Tax Expenditures.” To reduce taxpayer burden and enhance public confidence in the integrity of the tax system, the report urges Congress to greatly simplify the tax code. In general, this means Congress should reassess the need for existing income exclusions, exemptions, deductions and credits (generally known as “tax expenditures”). For fiscal year (FY) 2013, the Joint Committee on Taxation has projected that tax expenditures will come to about $1.09 trillion, while individual income tax revenue is projected to be about $1.36 trillion. To put these numbers in perspective, if Congress were to eliminate all tax expenditures, straight math indicates it could cut individual income tax rates by 44 percent and still generate the same amount of revenue it collects under current rules.
Tax Policy Decisions and Revenue Decisions Should Be Made Separately and Then Married Up. The report recommends that Congress approach tax reform in a manner similar to zero-based budgeting. The starting assumption would be that all tax expenditures would be eliminated. A tax break would be retained only if a compelling case can be made that the benefits of that break outweigh the complexity burden it creates. “In performing this analysis,” Olson said in releasing the report, “we should look at each provision in the code and ask questions like: ‘Does this government incentive make sense?’; ‘If it does, is it better administered through the tax code or as a direct spending program?’; ‘However well intentioned, is it doing what it was intended to do?’; and ‘If yes, can it be administered without imposing unreasonable burdens on taxpayers or the IRS?’. At the same time, Congress can separately consider how much revenue it wants to raise, and it can then marry up our optimally designed tax system with our revenue needs by setting tax rates accordingly.”