Monday, April 23, 2018

What Is Tax Simplification, and Do We Even Want It?

by Neil H. Buchanan

When is a tax system simple?  That is an ultimately arbitrary and meaningless question, so a variation might (or might not) be more helpful: When is a tax system simpler?  Certainly, every politician in America claims that she or he knows what tax simplification is and how to make it happen.  Unsurprisingly, they are all confused -- sometimes in a well-meaning way, sometimes not, but unfailingly confused.

In my most recent Dorf on Law column, I claimed that the extremely regressive tax bill that Republicans (and only Republicans) forced through Congress in December did not simplify the federal income tax system.  Although that assessment should be uncontroversial, there are some interesting issues that can be teased out in thinking about whether and how to change the tax system with an eye toward simplification.

One of the many meaningless ways in which politicians and pundits try to convince people that the tax code is too complicated is by pointing to the number of pages (or words) in the Internal Revenue Code, often making an inane computation showing how far the tax code would stretch if the pages were placed end to end.  The idea is apparently that large numbers of pages of tax law are the very definition of a complex tax system.

As it turns out, this mistaken framing has already been thoroughly debunked.  When a right-wing anti-tax group declared a few years ago that the tax code was 70,000 pages long, debunkers were on the case, pointing out that the Code itself is less than four percent of that total (2600 pages), and even IRS guidance on how to interpret the Code (regulations, revenue rulings, and so on) fails to bring the total to 9000.

The rest of that 70,000 is annotated caselaw.  As one observer noted, Congress cannot make that caselaw go away.  True enough, but Congress does have the ability to make it irrelevant.  Should it do so?  If so, it should not be because of the page count but for some substantive reason.  There are plenty of pages in the Bible, the Harry Potter series, and the collected works of Shakespeare; depending on your philosophical views, not all of those are as important as the tax code, but there are no demagogues calling for those sources to be cut down to size.

But surely I must be kidding to suggest that the Internal Revenue Code is in any way comparable to those other works, right?  Not really.  People care about Noah, Hermione, and Juliet, but they also care about whether their mortgages are deductible and whether they can take money out of their 401(k)'s to pay for the children's college tuition.

Life is complicated, and people want the tax code to be responsive even to the smallest differences in people's situations.  My favorite example is the bipartisan call to make the Olympic prize money that American athletes now win (not the medals themselves but the cash bonuses from the USOC) to be exempt from taxation.  Rather than saying, "Income is income, and yours should be as taxable as mine," people say, "Oh, these heroes are so different that the tax code should include a special carve-out for them."  And then they find other "special" situations to justify further exceptions.

People love simplification as an abstract goal, but they hate it when bright-line rules prevent them from getting special treatment.  Again, however, we do not need to bother with the question of absolute simplicity when we might at least make some progress in a comparative sense.  What would a simpler tax code look like?

One reason that the page-count approach makes so little sense is that most of the tax code is utterly irrelevant to most people.  One of the debunkers of the 70,000-page myth needlessly conceded that "professional tax lawyers need to know all the regulations and case law included in the Tax Reporter," but then correctly noted that "that has basically nothing to do with how the figure is used by actual politicians."  It is not actually true that tax lawyers need to "know all the regulations and caselaw," because lawyers only need to know how to find the information that they need when they need it, but there is a much more important aspect to this issue.

That tax lawyers need to be able to do competent legal research distinguishes tax law not at all from any other area of law.  Do people need to know the criminal code and all relevant case law in order to live their day-to-day lives?  Of course not.  At most, people have to have a sense of what crimes they might be able to commit and to know how to avoid going over lines that they do not want to cross.

Most of the tax code, administrative guidance, and caselaw are relevant only for a relative handful of taxpayers.  In my basic tax course, for example, I teach about "like-kind exchanges" and the rules for "boot and basis" in structuring such exchanges.  It is an interesting set of tax issues (in the geekiest sense of the word "interesting"), but those issues are not likely to arise for anyone in their day-to-day lives.  That is why businesses seek competent legal advice.  (As an aside, we could eliminate like-kind exchanges entirely, but -- for reasons too far afield to go into here -- that would make farmers unhappy.  Guess what Congress does when it thinks farmers will be unhappy?)

We are, therefore, now thinking about the relative complexity of the tax code from the perspective of different actors.  When we wonder if it is simpler, we need to ask: Simpler for whom?

All of which brings me back to what might look like a contradiction in my Dorf on Law column from last Thursday.  There, even as I stated confidently that the tax code had not been simplified by Congress's recent efforts, I also noted that a large fraction of people would not be able to take many of the deductions that they have been accustomed to taking.

Why is that potentially a contradiction?  Another way to say that people can no longer take certain deductions is that people do not have to fill out the forms that are required to substantiate those deductions.  Less paperwork!  As I noted on that column, prior to 2018, only about 30 percent of taxpayers were itemizing their deductions, but under the new law, it appears that only about five percent of taxpayers will still choose to itemize.

If that is true, we could say that the 70 percent of the people who did not itemize before and will not itemize now are no better or worse off in terms of simplicity.  Similarly, the five percent who will continue to itemize see no change.  But one-fourth of the nonbusiness taxpayers in the country would be "freed" from itemizing.  Is that not a big blow for simplification?

Again, the problem is that the standard formulation of this issue misstates the true nature of simplicity.  Last year, Donald Trump joined in the longstanding Republican sophistry regarding "postcard-sized tax returns" (only to ignore that framing when it became inconvenient).  As I pointed out in last week's column, if one's measure of simplicity is the number of lines on a form, the 1040-EZ is pretty darned simple.

Even so, I was only making that point to expose the Republicans' persistent disingenuousness about what counts as complexity.  Honestly, if we were only worried about how many lines there are on a form, and 70 percent of the people have already had their tax lives stripped down to EZ-level filing, there would be no reason for politicians to promise further simplification as a crowd-pleasing talking point.

And if we think about whether a typical itemizer in the pre-2018 system feels happy about no longer needing to itemize or instead feels that she would like to itemize (but finds that, say, her state-and-local tax deduction has been capped and thus is not even worth using anymore), the answer has nothing to do with simplicity or complexity.  From the most basic tax-minimization point of view, that kind of simplification is at best a distant second-order consideration.

All of this, moreover, incorrectly assumes that people who do not need to itemize do not have to do any work in order to figure out whether or not they should itemize in the first place.  That assumption was false under the old system, too, which is why my 1040-EZ reference is merely a "taking the argument on my opponents' terms" move.  In any event, that assumption is also false now.  And there is no reason at all to assume that the amount of work necessary to figure out whether one should itemize is in any way correlated with how many people end up doing so.

As yet one more consideration, note that the "work" that we are talking about here involves only the effort involved in computing one's taxes.  Changes in tax rules, however, cause people to try to figure out whether they should arrange their affairs or conduct business differently than before.  Millions of people are now trying to figure out whether they can sneak into the sweetheart "pass-through entity" loophole that Congress created.  Many more are trying to guess how the laws will inevitably be changed again (and how soon), given that the new system is clearly unsustainable politically.

In the end, do we want tax simplification?  Only if we do not have to give up anything else to get it.  There are truly simple tax systems, the worst of which is the "per capita tax" (or, to the Brits, a "poll tax"), under which every person pays the same number of dollars (or pounds) in taxes every year, without exception.  Simple?  You bet.  Preferable?  Not on your life.

The reduction in the number of itemizers, therefore, does offer the veneer of simplification.  But because that is a meaningless way to define simplicity, there is no reason to say that the new law is simpler for anyone.  There are a lot of new provisions and yet-to-be-written clarifications that will determine how complicated the tax system feels to people.

And whether or not it is simpler or more complicated, what ultimately matters is whether the tax system meets other goals.  The system as now written will make the United States an even more unequal society, and that is a much more important consequence of tax policy.

4 comments:

Michael C. Dorf said...

Here's a further thought about those tens of thousands of pages of case law: To some extent, there will be an inverse correlation between the length of the code and the volume of litigation that ensues. As a general matter, standards are shorter than rules. E.g., "drive safely, all things considered" is five words, whereas a code specifying speed limits, when passing is permitted, when which kinds of lines can be crossed, etc., is much longer. But the longer code of relatively clear rules will give rise to less litigation over such matters as what is a safe speed. Now obviously this is only an approximation to first order. Additional rules can themselves give rise to interpretive disagreements. Still, if the reason for a code's length is the lawmaker's effort to specify results in advance, then there will be a tradeoff between the brevity of the code and the volume of litigation. So those people who were claiming that the reports of the decisions made the Internal Revenue Code very long were not just lying, they were confused: The large volume of cases was arguably evidence that the Code was too standard-like and not rule-like enough, i.e., that the Code was too short.

Shag from Brookline said...

Living in the Blue state of MA, in 2017 and years prior I itemized deductions on federal returns, primarily with SALT deductions. I calculated my estimated 2018 income tax for federal purposes based upon worksheets provided by the IRS, using relevant income items from my 2017 return expected in 2018. The estimate provides for the standard deduction as I cannot itemize the limited SALT deductions otherwise permitted because the standard deduction would be greater. I had no earned income in 2017 and do not expect any in 2018. My estimated federal tax for 2018 would be at least 2.5 times my 2017 federal income tax. While I would eliminate Schedule A for 2018, that "simplification" will be expensive, rubbing SALT in my wounds because the elimination of SALT deductions seems to have been aimed at Blue states -TAXANIMUSLY!

Joe said...

I think the average person has pretty simple tax returns though some details can be confusing. To take a case somewhat common -- if a credit card forgives a debt, you have to declare it, but there is an additional form and worksheet to fill out that to a layperson seems a tad confusing. But, the complexities as noted is a result of people wanting it. Parliaments came about in large part because of the power of the purse and that tends to result in fine tuning.

I'm sure a person can find specifics where simplification is a good idea but it amounts to stray things in a field.

Shag from Brookline said...

Tax policy often works in conjunction with economic policy. Consider the economics behind the American Dream of owning a home: It creates many jobs. To encourage home ownership, tax policy permitted itemized income tax deductions for mortgage interest and local property taxes. Renters did not obtain similar deductions at the federal level, although MA has offered a limited benefit on state income tax returns to renters. Did this American Dream die? Is home ownership to be encouraged not only as a Dream but also because of the benefits to the economy as a whole? The Trump/GOP stake the rich tax law of 2017 did not eliminate the home mortgage interest deduction, but impacted local property tax deductions, in addition to state taxes. Property taxes support public education, once considered a "public good." State taxes provide "public goods" as well. The federal government has over the years cut back on funding states and local communities, which have balanced budget requirements. Cutting back on SALT deductions harms taxpayers living in states (mostly Blue) that have accommodated the American Dream, public schools, etc. Does this new tax policy beginning in 2018 clash with economic policy? What will be the impact on the need for affordable housing? Red States provide inadequate public education, as reflected by recent teachers' strikes, by such states' tax cutting measures. Who actually benefits from this shift in tax policy? Why, the wealthy and corporations. The goal of the 2017 Act is to get the wealthy to politically tithe to the GOP from their tax savings. It has nothing to do with simplification. Tax - together with economic - policy should provide a public good for all, not primarily the 1%ers, and it's not that complicated for most taxpayers.