Tax Code Complexity Slammed by Taxpayer Advocate

The federal tax code remain mind-numbingly complex; a fact National Taxpayer Advocate Nina E. Olson could have hardly made clearer when she wrote in her 2010 Annual Report to Congress, "The most serious problem facing taxpayers - and the IRS - is the complexity of the Internal Revenue Code.

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The Burden of Being Good

How serious has the problem of the tax code's complexity become? According to a Taxpayer Advocate Service (TAS) analysis of IRS data, individual taxpayers and businesses spend at least 6.1 billion hours a year trying to honestly and correctly file their federal tax returns.

"If tax compliance were an industry, it would be one of the largest in the United States," states Olson's report to Congress. "To consume 6.1 billion hours, the 'tax industry' requires the equivalent of more than three million full-time workers."

In addition to time, tax code compliance now bears a considerable monetary cost as well. Driven by tax stress over "getting it wrong," or missing legitimate tax deductions, some 60% of individual taxpayers now pay tax preparers to do file for them. Another 29% use tax software packages, typically costing at least $50. According to Olson's report, the IRS itself has estimated that the annual average cost for an individual tax payer to comply with the federal tax code (as measured by income) is now $258.

For business and self-employed individuals, the cost of complying with the tax code is even more severe. According to Olson's report, TAS estimated the cost of complying with corporate income tax requirements in 2008 at $163 billion or "a staggering 11 percent of aggregate income tax receipts."

Why the Tax Code is so Complex

According to Taxpayer Advocate Olson, the primary reason for the complexity of the federal income tax code is the law's sheer, overwhelming size. Consider these details from Olson's 2010 Report to Congress:

• Over the last 10 years, there have been 4,428 changes to the tax code, an average of more than one a day, including 579 changes in 2010 alone.

• The tax code has grown so long, that it has become challenging even to figure out how long it is. According to Olson's search done in 2010, the tax code contains 3.8 million words. A 2001 study published by the Joint Committee on Taxation put the number of words in the tax code at that time at 1,395,000. A 2005 report by a tax research organization put the number of words at 2.1 million, and notably, found that the number had almost tripled since 1975.

• The income tax regulations issued by the Treasury Department to provide guidance on the meaning of the Internal Revenue Code now stand about a foot tall. The CCH Standard Federal Tax Reporter, a leading publication for tax professionals that summarizes administrative guidance and judicial decisions issued under each section of the tax code, now comprises 25 volumes and takes up nine feet of shelf space.

The Dangers of Tax Code Complexity

The complexity of the tax code leads to what Olson's report calls "perverse" results.

"On the one hand, taxpayers who honestly seek to comply with the law often make inadvertent errors, causing them to either overpay their tax or become subject to IRS enforcement action for mistaken underpayments. On the other hand, sophisticated taxpayers often find loopholes that enable them to reduce or eliminate their tax liabilities."

In addition, reported Olson, taxpayers who can afford professional tax advice are often able to profit from special tax breaks obscured by the tax code's complexity, while less financially fortunate taxpayers are discriminated against and left feeling like "tax chumps."

"Taxpayers who believe they are unfairly paying more than others inevitably will feel more justified in 'fudging' to right the perceived wrong," Olson wrote. "The outcome of this situation is predictable -- taxpayers develop a sense of cynicism about the tax system and the government that has foisted it on them, and tax compliance takes a hit."

Tax code complexity also leads to tax code noncompliance, which cheats honest taxpayers, who have to make up the difference, notes Olson. The difference is called the "tax gap" which amounted to $290 billion in 2001. According to Olson's report, the means the average taxpayer was effectively paying a "surtax" of some $2,200 to subsidize noncompliance by others.

Tax Code Complexity and the IRS

If you think the IRS' more than 100,000 employees do not suffer from the complexity of the tax code, you would be wrong. According to Taxpayer Advocate Olson's report, while 90% of taxpayers now depend on tax preparation software, the IRS still takes over 50 million calls for help per year - 110 million in 2009 and 2010 - but is unable to answer more than a quarter of them. "In fiscal year (FY) 2008, the IRS received approximately 167 million calls overall, largely inquiries generated by the Economic Stimulus Act, and was only able to answer 53 percent," states the report.

Olson's report also describes other challenges faced by the IRS due to tax code complexity.

"To cite one example, the IRS cannot process on a timely basis a considerable portion of the more than 11 million pieces of taxpayer correspondence it receives each year. This situation leads to erroneous tax assessments, improper collection actions, additional penalties and interest for taxpayers, and additional refund interest costs to the government."

In other words, says Olson, simplifying the tax code would benefit both taxpayers and the IRS. So, why doesn't it happen?

Why Isn't the Tax Code Being Fixed?

As far back as 2000, Taxpayer Advocate Olson called on Congress to simplify the tax code, but nobody listened. "There has been near universal agreement for years that the tax code is broken and needs to be fixed," Olson said in releasing her 2010 report. "Yet no broad-based attempt to reform the tax code has been made."

While Taxpayer Advocate Olson acknowledges the widely-held belief that the political influence of powerful "special interests" prevents comprehensive tax code reform, she contends the "dirty little secret" is that the largest and most influential special interest group of all is "us - the vast majority of U.S. taxpayers."

Virtually all taxpayers, says Olson, take advantage of legal income exclusions, deductions or any number of congressionally granted tax credits in order to reduce their tax payments or maximize their refunds.

According to Olson, attempts at tax reform have failed largely because of reluctance on the part of taxpayers to let go of the very thing that prevents Congress from lowering tax rates - tax breaks.

"It is sometimes suggested that taxpayers are looking for a free lunch - that they want to see lower tax rates but keep their tax breaks and retain their government benefits, all while balancing the budget," Olson said. "But this perspective overlooks the fact that federal tax and spending policies are complex, and most people don't have the time to study these policies in detail. Our aim is to improve public knowledge of the trade-offs involved and to help policymakers and the taxpaying public conduct a more informed conversation about tax reform alternatives."

Olson Calls for a 'Taxpayer Receipt'

Tax code complexity, concludes Olson in her report, enforces the "sense of distance" taxpayers feel between themselves and their government. This us-against-them feeling results in falling tax compliance rates, which ends up hurting both the government and taxpayers. "This may seem abstract, but voluntary compliance is central to our tax system, so this "distance" must be addressed," states Olson. "We believe that simplifying the tax code would be a big step in the right direction."

To help close the distance between taxpayers and the government, Olson recommends Congress provide all taxpayers with an annual "taxpayer receipt" presenting a breakdown showing exactly how their federal tax dollars are being spent. "For the reasons discussed above, we believe better public awareness of the connection between taxes and government spending may improve civic morale, improve tax compliance, and make more productive the national dialogue over looming fiscal policy choices."

Also See: Is a 'Fair' Tax in America's Future?