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Want a Better IRS? Simplify the Tax Code

The biggest problem facing the IRS isn’t bad management or lack of resources, but the metastasizing complexity of the tax rules it must administer.

(Bloomberg Opinion) -- One of the most conspicuous parts of the tax-and-spending package known as the Inflation Reduction Act is vastly expanded funding for the Internal Revenue Service. The promised flood of cash — an additional $80 billion over ten years, compared with baseline annual spending of around $15 billion — raises some questions, and one of the most important is getting less attention than it should. If the IRS lacks the means to do its job well, could that be because its job is far more demanding than it ought to be?

In a word, yes: The IRS struggles to administer the system because US taxes are insanely complicated. In this respect, the purportedly bold innovation on funding for the agency is partly a tribute to the status quo. The enormous increase in spending is combined with another new batch of complexities. Highlights include incentives for climate-related investments and assorted other good things, and a minimum corporate tax that requires eligible companies to calculate what they owe not one way but two, then pay the larger sum.

Changes like these serve legitimate purposes, but they are partly self-defeating. With one hand you incentivize decisions that serve the public interest; with the other, you cancel them out by closing “loopholes.” On top of which, every further complication is an opportunity for tax avoidance, an added compliance burden on taxpayers and the IRS alike, and a transfer of income from producers of socially valuable goods and services to accountants and lawyers eager for their share of the resulting deadweight loss.

The US tax code hasn’t been comprehensively simplified since 1986. Over the subsequent years, Congress has indulged its unlimited appetite for making it unintelligible. (Back in 2010, a panel chaired by Paul Volcker reported that taxpayers and businesses spend 7.6 billion hours and “significant out-of-pocket expenses” to do their taxes each year, a cost equivalent to at least $140 billion, which was 12 times the IRS budget or 10 cents per dollar of income tax paid.) What a mess. And what a shame that the new IRS budget isn’t part of a plan to fix it.

In a narrow sense, the extra spending does make sense. My colleague Tyler Cowen argues that the IRS is badly run and should be told to smarten up before it gets more money — a fair point, given the agency’s failure to modernize its systems and make better use of its existing resources. But the squeeze on its budget (a cut of about a fifth in real terms since 2010) and the relentless rise in its workload (lately aggravated by the pandemic) would test any undertaking, especially one that was stressed to begin with.

Although the bigger budget will raise more revenue than it costs, there is much debate over just how big this bonus — revenue available to pay for more public spending and/or lower tax rates — will be.

The Congressional Budget Office estimates that the $80 billion will raise about $200 billion in additional revenues. Larry Summers and Natasha Sarin (who now works in the administration) explain that the methodology behind such estimates ignores or plays down the effects of better taxpayer service, updated technology and better voluntary compliance. The IRS reckons the gap between what’s owed and what’s collected is roughly $7 trillion over 10 years; Summers and Sarin think the extra funding should easily cut that by $1 trillion.

Their arithmetic looks plausible — only keep in mind that the tax gap is not the best way to judge the system. The compliance burden is a cost in its own right, and if you cut the gap by increasing the burden, it’s a mixed blessing. The goal should be to cut the gap while reducing the burden. That’s entirely possible, and you do it by simplifying the code.

One example should suffice. The US provides tax relief for certain kinds of retirement saving. Security in retirement for people who might otherwise lack it is a worthy purpose, and most countries offer tax-advantaged treatment for those on middle and low incomes. But none that I know of rival the US for the Kafkaesque convolutions of its approach (many of which conspire, it so happens, to narrow the benefits to those with high incomes and accountants on retainer).

Some employer-based schemes — 401(k)s, 403(b)s and so on — are relatively straightforward. But then you’ve got Individual Retirement Accounts: “traditional IRAs” (including “Stretch IRAs”), Roth IRAs (not forgetting “Back-Door Roths”), Payroll Deduction IRAs, Simplified Employee Pensions, “SIMPLE IRAs” (it stands for Savings Incentive Match Plan for Employees), and SARSEPs (Salary Reduction Simplified Employee Pension Plan). Now, if all those very simple simplified schemes strike you in fact as a bit complicated, brace yourself and look at the IRS page explaining the rules for drawing down these accounts. Be sure to follow the links! You wouldn’t want to make a mistake — especially now that your chances of being audited are about to go up.

For decades, whenever Congress has “reformed” the tax code, it has just layered on new complications. The US now has a system that might have been designed to fail, incentivize avoidance, perpetuate a colossal tax gap, and drive taxpayers and IRS officials alike out of their minds. The biggest problem with the IRS is not that it’s been badly managed (though perhaps it has been) or under-resourced (which it undoubtedly has been), but that hyperactive legislators have given it an impossible task. Sadly, $80 billion won’t come close to putting that right.

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To contact the author of this story:
Clive Crook at [email protected]

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