Sunday, December 3, 2017

Simplifying the Paying of Taxes—and Saving a Lot of Money

While people will always argue about who should be paying what level of taxes, all would agree that the very process of paying taxes is painful, needlessly complicated, time consuming, and becoming expensive as more people are forced to seek help in filing their returns.  T. R. Reid addresses this issue at length in his recent book: A Fine Mess: A Global Quest for a Simpler, Fairer, and More Efficient Tax System.  In it, he tells us that the tax code does not have to be as complicated as it has become, and that there are other filing mechanisms that are much more accommodating for the taxpayer.  Reid’s goal is to survey systems in place in other countries and determine the approaches that would benefit the United States.  We have a lot to learn from other countries.

Much of our problem arises from the complexity built into tax code.

“The U.S. tax code has grown so huge that nobody really knows how long it is.  During the 2016 presidential campaign, candidates routinely cited a figure of seventy-three thousand pages—a number that seems to include thirty-five hundred pages of the law itself, plus another seventy thousand pages of regulations.”

We tend to curse the IRS when we struggle with our forms, but the real culprits are our representatives in Congress.

“Members of Congress love to harangue the IRS bureaucrats about lengthy tax forms and unfair rules and complex instructions—but of course the IRS isn’t responsible for the length, the fairness, or the complexity of our tax code.  It is Congress that writes the tax laws.  It’s Congress that adds hundreds of new exemptions, allowances, credits, and calculations to the tax code every year.  It was Congress that decided to give the IRS the responsibility for managing the health insurance subsidies flowing to millions of Americans under the Affordable Care Act (Obamacare)—and then cut the agency’s staff after assigning it this major new task.  It was Congress that assigned to the IRS the management of the earned income tax credit (EITC), which has become one of the nation’s largest support programs for low-income Americans.  It was Congress that crafted the much-hated alternative minimum tax, which spawned whole new levels of complexity, and hours of additional work, for millions of families.  And yet congressmen and senators can’t seem to resist pointing angry fingers at the IRS, as if someone else had created the legislative monster that is the U.S. tax code.”

Reid points out the perversity of a code which burdens those least able to afford tax-paying assistance with some of the most complex filing procedures.  He uses the EITC, which provides a payment to support low-income workers and families, as an example.

“The instruction book for low-income taxpayers hoping to get this benefit (Publication 596) is fifty-nine pages long.  The book lists fifteen separate conditions, spread over three chapters, that you have to meet to claim the credit….The whole thing is so complicated that the error rate is 27%, which means one out of four filers, and the IRS, have to spend even more time trying to get it right.  This has prompted a mini-industry of tax fraud, with shysters going door-to-door in low-rent neighborhoods offering to fill out the EITC forms (for a fee of course) whether the client actually qualifies or not.  Similarly the tax credits for people buying health insurance on the ObamaCare exchanges are generally aimed at low-income taxpayers and are also ridiculously complicated.”

The IRS has the appearance of being an efficient agency in that its cost for collecting taxes compares with the best in the world at that task.  However, it does that by putting the burden of tax filing completely on the taxpayer.

“While the tax agency spends $11.4 billion, American taxpayers end up paying vastly more just to file their annual returns.  The Office of the Taxpayer Advocate says American families spend 3.16 billion hours each year getting their taxes done—gathering the data, keeping records, and filling out forms; businesses spend about 2.9 billion hours on the same tasks….At an average wage, those 6 billion hours devoted to filing tax returns represent about $400 billion per year of working time; six billion hours is the equivalent of 3.1 million people working forty hours per week, fifty weeks per year.  In terms of time and cost, just paying our taxes has become one of the biggest industries in the United States.”

The complexity of the process is such that very few people remain who attempt to perform the task on their own.

“Because the system is so complicated, hardly any Americans still fill out Form 1040 by themselves….Today, barely 10% of Americans do their own tax returns.  About 60% of all individual taxpayers hire tax-preparation agencies to do the work for them; another 30% buy tax-preparation software each year to get them through the process.  The IRS says an average family at medium income shells out about $260 per year for tax-preparation services; those with higher incomes can easily pay ten times as much.”

One of the curious features of filling out income tax forms is that you are spending a lot of time giving the IRS information it already has.  Given that, and the possibility that an effort could be made to arrive at revenue-neutral simplifications, and a small expansion of reporting requirements could be made, one should be able to arrive at a system in which the IRS fills out your tax forms for you and just sends you a summary to approve or dispute.  That is just what other countries have done, with more of them pursuing that goal.

Consider Japan’s system of tax collection.

“Japan’s equivalent of the IRS, Kokuzeicho, gathers all the pertinent data for each worker—income, taxable benefits, number of personal exemptions, tax withheld, and so on—and then computes how much the worker owes in tax, down to the last yen.  Because Japan uses a system known as ‘precision withholding,’ with the amount changing whenever pay goes up or down, most people withhold the exact amount due.  In early March, Kokuzeicho sends a postcard to every citizen that sets forth all this information: how much you earned, how much tax you owe, how much tax you’ve already paid through withholding.  If you’ve paid in more tax than you owe, Kouzeicho deposits the refund amount in your bank account; if you did not withhold enough, the agency takes the tax that’s due from your bank account.  If the figures on the postcard look about right, the taxpayer does nothing.  The tax has been computed and paid already.  If the numbers look wrong, you go into the local tax office and try to straighten things out.  As a result, paying income tax is a totally automatic process for about 80% of Japanese households, requiring no more than reading a postcard once a year.”

Britain has a system that is similar to that in Japan.  In fact it maintains a bureau called the U.K. Office of Tax Simplification (OTS).

“….the office has made some four hundred formal proposals to simplify either the tax code or the tax return forms and 50% of them have been implemented, at least in part.”

“The U.K. has established a system rather like Japan’s, with Her Majesty’s Revenue and Customs filling in the tax return with data it has received from employers, banks, brokerage houses, charitable recipients and so on.  The Brits also use a ‘precision withholding’ system, called Pay as You Earn, or PAYE, which takes into account wages and benefits, Social Security and health-care deductions, student loan deductions, and various other adjustments to income.  With that, most British wage earners find their yearly total tax withholding just about equals the tax they owe; in 2014, according to the Office of Tax Simplification, only one in five Brits had to file a tax return.”

Reid lists a number of countries that have followed or are beginning to follow the path taken by Japan and the U.K.: the Netherlands, Denmark, Sweden, Spain, and Portugal.

Implementing such a system in the United States would be much easier if the tax code were simpler: there basically would be less data to collect.  It would be expensive to move in this direction, but the data indicates that a simpler system increases compliance with tax laws; the initiative would soon pay for itself with increased revenue.

Reid points out that such a system already exists as a trial project in California for state taxes.

“California has launched what it calls an ‘experimental’ program known as CalFile in which the revenue department will send you a state tax return that is already filled in; if the numbers look right, you sign it, and the work is done.  If they don’t, you send back the return with your changes.  The state has never spent much money to publicize this system, so it is poorly known and little used.  But of the ninety thousand Californians who did file through this prefilled form in 2012, 98% subsequently told pollsters that they loved it and would definitely use it again.”

Such a system could be implemented in the United States.  There is no reason, other than politics, why software like the commercial tax filing programs couldn’t be implemented by the IRS thus saving the public billions of dollars in unnecessary expenses.  But many of our legislators are not in the business of representing their constituents; rather, they are tasked to represent the corporations that feed them money for reelection campaigns.

“It turns out that the complexity of the U.S. tax system is a money maker for some large companies.  So they have lobbied strenuously, and successfully, against all efforts to simplify the tax code.  The ‘Tax Complexity Lobby,’ as Forbes magazine called it, includes tax-preparation firms like H&R Block and Jackson Hewitt, as well as companies that make tax-preparation software.”

“The biggest spender in the anti-simplification camp is Intuit, the maker of Turbotax, the top-selling tax software program.”

Yes, the United States continues to strive to be “exceptional,” whether for the good or the bad.

The interested reader might find the following articles informative:

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