Obama’s new tax plan shows what a mess the tax code already is

Published on: Jan 23, 2015 | Tagged in: News,News


 

President Obama and many other poobahs in Washington, D.C., say it’s essential to simplify the U.S. tax code. But for now, it’s necessary to complicate it.

Obama’s tax proposals for 2015 include a new “second earner” tax credit, an expansion of the earned-income tax credit, new tax incentives to help cover child-care expenses, and several provisions meant to make higher education more affordable. Economists say they’re generally sensible ideas, yet they’d make the burden of filing a tax return even more onerous than it already is.

“The IRS would have to figure out how to put all these pieces onto a two-sided EZ tax form,” says Roberton Williams of the nonpartisan Urban Institute. “There’s nothing ‘EZ’ about this.”

Because many of Obama’s tax proposals target lower-income workers, the burden of parsing increasingly arcane tax provisions would fall more heavily on taxpayers least able to afford accountants or other costly tax advisors. Only about 10% of filers do their taxes themselves these days, with 30% using software such as TurboTax or TaxAct and 60% using a tax-prep service, including inexpensive ones such as H&R Block. Even so, complexities dog lower-income filers.  The document listing eligibility guidelines for the popular earned-income tax credit (IRS Publication 596), for instance, is 37 pages long. The provisions explaining what constitutes a “qualifying child” take up five pages and detail at least 16 different possible parent-child scenarios. And that’s without any of Obama’s enhanced provisions.

Taxpayers this year also must indicate on their tax forms whether they had health insurance in 2014. That’s the new provision of the Affordable Care Act requiring all adults to have coverage. For those in compliance, it ought to be no big deal. But those who violated the so-called individual mandate are supposed to pay a penalty that will come out of any tax refund they receive. It’s not yet clear how the IRS will deal with people who owe the fee but don’t get a tax refund.

 

Efforts to change social policy or extend aid to various subsets of the U.S. population usually go through the tax code because that’s the one way nearly everybody with a financial presence interacts with the government. It’s also more palatable, politically, to frame government aid as a tax credit or deduction than as an outright giveaway, even though there’s not always a lot of difference. The countless targeted distortions in the tax code — all of them meant to help some group deemed worthy, at some point in time — explains why the U.S. tax code has swelled to amonstrous 75,000 pages or so, nearly a threefold increase since it was last simplified in 1986.

Adding layers of complexity

Complexity generates confusion and widens the opening for fraudsters, two chronic problems with the U.S. tax code. The EITC, for instance, is generally considered an effective way to reduce poverty, yet a 24% error rate leads to $15 billion in improper payouts to tax filers each year, according to the U.S. Treasury. Fraud may be one reason, but the nonprofit Tax Foundation also argues that “the program is rather complex … [which] leads to people making mistakes.” The Internal Revenue Service, meanwhile, estimates that about 20% of people who qualify for the EITC don’t apply because they don’t know they’re eligible.

Obama’s proposals would layer more tax incentives onto this confounding patchwork, at a time when Congress is cutting the IRS’s budget, limiting its ability to guide taxpayers through the rules and pursue cheaters. Many Americans may applaud cutbacks at the nation’s tax-collection agency, yet wait times for phone inquiries have risen from 11 minutes in 2010 to 18 minutes, with the IRS never even answering 40% of calls. Prosecutions of tax violators have trailed off, too — which means the tax burden is falling even more heavily on those who play by the rules.

Obama claims his tax plan would simplify a few minor parts of the tax code, by consolidating the number of education tax credits, for instance. Yet Republicans say they’ll never agree to tax hikes on the wealthy– which Obama wants to offset the cost of his tax cuts for the middle class–that could total more than $30 billion per year. So Americans may be spared any further tax complexity, for now.

Why not simply scrap the existing, convoluted tax code and start over? That’s been the aim of reformers calling for a flat tax and other schemes meant to streamline the existing tax system. While those ideas mey may be simpler, they’d also threaten many powerful interest groups that like the tax code just the way it is and fight hard against changes that might leave them worse off.

“There’s a temptation to just throw it out and implement a new program,” says William Gale of the Brookings Institution. “But there are a lot of people benefiting from these complicated provisions. It’s depressing to see this happen again and again.”

Like other politicans of both parties, Obama has said many times that the tax code needs an overhaul. But the only big change he’s really pushing hard involves corporate tax reform. And even that may be too contentious for Washington to pull off any time soon. If you’ve got a good tax advisor, it might be wise to sign a long-term contract.