The tax code: a playground for the few, a labyrinth for the many

Every year, Americans pay tax preparers billions of dollars to file our taxes. But 70 percent of us are eligible 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 error 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 taking it on without a lawyer.

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. For many of us, filing our taxes isn’t so much about filing our income as it is about providing the IRS with free secretarial service.

Although a dangerous pain for taxpayers, the cesspool of confusion, inefficiency and manipulation that is the federal tax code will not be simplified, as the code offers a multitude of benefits to lawyers, tax accountants, favored industries, lobbyists and politicians.

The benefits for 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 filings, the annual cost of complying with our Byzantine Code is approaching $40 billion. But in most cases, the tax code is a job creation program. Congress is digging legal holes and we are paying lawyers and accountants billions of dollars a year to fill them again.

Favored industries and lobbyists benefit more subtly. The more complex the tax code, the easier it is for politicians to bestow favors on their favorite groups without attracting attention. Giving special tax treatment to a favored industry is as simple as hiding a needle of a few select phrases in a 70,000-page haystack. Industries pay lobbyists to encourage politicians to hide these needles from public view, and politicians receive political and financial support from industries in return. This symbiotic relationship between favored industries, lobbyists and politicians thrives in an environment of complexity.

Meanwhile, complexity benefits politicians who come and go. As politicians receive support from industries by hiding giveaways in the tax code, as election season approaches, politicians are denouncing the tax code and promising voters that they will fight complexity on behalf of voters. 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 is passed on to voters in the form of higher prices, lower wages, or lower returns. Politicians vow to make the wealthy pay their fair share, while counting on voters not to notice that the top 10% of taxpayers are already paying 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 simple, easy-to-understand tax code would reduce the influence of lobbyists and industries by making it harder for politicians to grant 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 documents.

Interestingly, the story suggests a straightforward simplification of what economists call, informally, “Hauser’s Law.” It turns out that for the past seventy years, it didn’t matter whether Congress taxed the rich or the poor, whether it taxed corporations or individuals, whether it taxed capital gains or wages, whether it taxes a lot or a little. The result has always been the same: the federal government has collected about 18% (plus or minus 2%) of the economy In tax revenues.

If 18% is the answer, no matter how simple or complex, let’s keep it simple and tax all income at 18% – 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 experts were in favor, we would still end up with a complex tax code. For what? Because we all want a simplified tax code except for our favorite exclusions. Homeowners will say that not being able to deduct mortgage interest is not fair. Investors will argue that it is not fair that capital gains are taxed the same as wages. Those with chronic health conditions will say that losing their medical expense deductions is not fair. The poor and the middle class will say that it is not fair that they pay the same tax rate as the rich.

While few people benefit from a complex tax code as much as politicians and people in political orbit, we each benefit in a bit of different ways. Keep each of these small ways different 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 get angry about what we believe the wealthy should pay, we tend to imagine the idle wealthy, living a high life on passive income. What we don’t imagine are hard-working, middle-class people who have amassed wealth through perseverance and frugal living. An income tax hits the frugal and the industrious. A consumption tax hits idle spenders. The main obstacle here is that a national sales tax would likely require a constitutional amendment. And, if we did not simultaneously repeal the 16th Amendment, which established the income tax, we would end up with a national sales tax And an income tax. A consumption-based tax would be more visible to consumers because they would see the tax applied every time they buy something. This would make it harder for politicians to hide tax favors and harder to sneak in tax increases.

The complexity of the tax code has created an environment in which tax preparation services, lobbyists, favored industries and politicians thrive, while taxpayers struggle to understand 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 advantage. Companies would focus more on growth and innovation, instead of co-opting a labyrinthine tax code. Entrepreneurs would focus more on attracting consumers than politicians. Politicians would focus more on satisfying voters 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 countering the problems that Congress is creating for the rest of us. We.