Updated February 02, 2013
Every year, U.S. Taxpayer Advocate Nina Olson tells Congress that the federal income tax code is too complicated, and every year, Congress responds by making it even more complicated.
The Taxpayer Advocate Service first complained about income tax complexity in its 2001 report. Since then, notes Olson, Congress has responded by making nearly 5,000 changes to the tax code, an average of more than one a day, and growing the number of words in the tax code to nearly four million.
Paying for Tax Paying Complexity
In her 2012 report, Olson tells Congress pretty much the same thing she told lawmakers in 2011. "The existing tax code makes compliance difficult, requiring taxpayers to devote excessive time to preparing and filing their returns, and leaving many unaware how their taxes are computed and even what rate of tax they pay," she wrote.
But this year, with the U.S. government constantly in danger of falling off fiscal cliffs, exceeding its debt ceiling and shutting down all together, Taxpayer Advocate Olson stressed how the complexity of paying income tax contributes to the "tax gap" which now costs the government over $350 billion a year.
As Olson tells Congress, the complexity of the tax code, "enables sophisticated taxpayers to reduce their tax liabilities and provides criminals with opportunities to commit tax fraud; and by creating an impression that many taxpayers are not compliant, it undermines trust in the system and reduces the incentive that honest taxpayers feel to comply."
Protecting the Income Tax Industry?
Does Congress intentionally perpetuate the complexity of the tax code in order to protect the jobs in the nation's "tax industry?"
In preparing its 2012 report, the Taxpayer Advocate Service (TAS) found 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."
Instead, as Olson points out in her report, nearly 60% of taxpayers hire paid tax preparers or tax preparation services. Another 30% depend on commercial software packages, often costing $50 or more. "In other words," notes Olson, "taxpayers must spend money just to figure out how much money they owe."
How Can Congress Reduce the Complexity?
According to Taxpayer Advocate Olson, the best way for Congress to both simplify the tax code and restore public confidence in the integrity of the tax system would be to eliminate existing income exclusions, exemptions, deductions and credits - items generally referred to in Congress as "tax expenditures" - and simply reduce tax rates for all taxpayers instead.
Exclusions to income are called "tax expenditures," because form the government's standpoint; they reduce the annual amount of revenue generated from collecting income tax.
However, as Olson points out in her report, if Congress eliminated all tax expenditures and simply gave all individual taxpayers a 44% tax cut, the government would collect just as much money, and the tax return process would become much less complicated.
IRS Service to Taxpayers Falling Again
Olson's report also notes that since peaking in 2004, the IRS's performance in handling phone calls and correspondence from taxpayers has steadily declined. In 2004, the IRS was able to respond to 87% of calls with a live telephone tax assistant, with an average on-hold time of just over 2.5 minutes. By 2012, the IRS managed to answer only 68% of its calls, while keeping the taxpayers who did get through on hold for an average of 17 seemingly endless minutes.
As for letters to the IRS, taxpayers sent it over 10 million letters during 2012. By the end of the year, 48% of all taxpayer correspondence remained unanswered, compared to only 12% in 2004.
Taxpayer Advocate Olson blames Congress' failure to adequately fund IRS taxpayer services functions for the falling phone and mail response rates.
Tax Related Identity Theft
Olson's report also includes the bad news that filing an income tax return these days brings you a substantially increased chance of becoming an identity theft victim. According to the report, the number of tax-related identity theft cases received by the Taxpayer Advocate Service increased my more than 650% from 2008 to the end of 2012. By the end of 2012, the IRS itself was trying to deal with almost 650,000 identity theft cases.
Olson says the problem has grown as organize crime perfects more ways of stealing taxpayers' names and Social Security numbers. The crooks file fraudulent tax returns using a taxpayer's name and Social Security number to obtain sizable tax refunds. When the actual taxpayer files a return claiming a refund, the IRS rejects the return as already filed.
The impact on taxpayers is significant, says Olson, noting that more than 75% of the victimized taxpayers are due refunds averaging about $3,000 each, which cannot be paid until the IRS fully resolves the case.