Section 6óTax Law Simplification

 

The Commission found a clear connection between the complexity of the Internal Revenue Code and the difficulty of tax law administration and taxpayer frustration. Compounding the problem of administration is the frequency with which Congress and the President change the tax law. Throughout the course of its review, the Commission found that the laws written by Congress and the President can lead to inadvertent noncompliance, increase the compliance costs of individuals and businesses, and add to the difficulty of revenue collection. While the Commission recognizes that much of the tax lawís complexity is a product of congressional and executive attempts to tailor the law narrowly while maintaining fairness, progressivity, and revenue neutrality, the fact remains that the law is overly complex and that this complexity is a large source of taxpayer frustration with the IRS.

Recognizing that Congress and the President must weigh the policy merits of any tax proposal, as well as the effects on progressivity and revenue, the Commission strongly recommends that Congress and the President work toward simplifying the tax law wherever possible.

 

Introduction

The success of our nationís tax administration system depends on continued voluntary compliance with the tax law. The Commission found that significant noncomplianceóboth inadvertent and intentionalóresults from various obstacles within the current system, including the cost of compliance and the complexity of the tax law. Reducing taxpayer burden by simplifying the tax laws and administration must start with the Congress and the President.

The largest cost of complying with the tax law is borne by the taxpayer. Perhaps one measure for the success of tax legislation would be to measure the cost to comply with and administer the law. While economists differ as to the actual cost of compliance, Professor Joel Slemrod has estimated that the cost to comply with the income tax each year is $75 billion. This estimate is staggering, particularly when compared to the size of the IRS annual appropriation of approximately $7.3 billion. For Congress to develop an adequate understanding of the compliance and administrative burden of the tax law, it must consider the impact of tax law changes on behavior, research and planning costs, and the costs of audits, appeals, and tax litigation.

Uncertainty also adds to complexity and the cost of compliance. Many compliance problems are a direct result of uncertain interpretation of the tax law. Tax regulations and other guidance, including the Internal Revenue Manual, assist both the IRS and taxpayers, but they must be interpreted consistently. Unlike other government regulations, tax regulations and guidance help taxpayers and practitioners understand how to comply with the law. Congress should not discourage Treasury and the IRS from writing regulations, particularly those that set forth broad principles, as they often lessen taxpayer burden, simplify the law, and promote confidence in the tax system and consistency in tax administration. In addition, because unpublished guidance can be equated to a secret code, Treasury and the IRS should share more information with the public through education about how the laws are administered.

 

1. Legislative Process

Congress should consider the administrability of proposed tax legislation, and should take immediate steps to improve the tax legislative process, including requiring a Tax Complexity Analysis for each tax proposal.

There currently is no mechanism in place to ensure that Members of Congress have a complete understanding of how proposed tax legislation will affect the IRS and taxpayers, and to create incentives to simplify the tax law. Furthermore, there is no mechanism in place to emphasize the importance of simplification in the legislative process.

To ensure that Congress understands the burden imposed on taxpayers and whether the IRS will be able to administer legislative proposals, and whether the proposals contribute to simplification or add complexity to the Internal Revenue Code, Congress should require any legislative proposal to be accompanied by a "Tax Complexity Analysis" before it can be considered in committee or on the floor of either the House of Representatives or the Senate. This requirement will increase the prominence of tax complexity early in the drafting process, when its consideration is more likely to affect the substance of legislation. In addition, this requirement increases the accountability of drafters by making tax complexity more transparent to Members of Congress, interest groups, and taxpayers. This requirement should be enacted as an amendment to the Budget Act, with point of order enforcement mechanisms, and should apply to any tax bill, amendment, or conference report.

Tax Complexity Analyses should identify the kinds of complexity, the extent of that complexity, and whether the provision could be recast to reduce complexity while still achieving its tax policy goals. To ensure uniformity, Congress should require the Analysis to consider the following eight issues:

 

· Whether the provision is new, or modifies or replaces existing law, and whether hearings were held to discuss the proposal and whether the IRS provided input as to its administrability;
· When the provision becomes effective, and corresponding compliance requirements on taxpayers (e.g., effective on date of enactment, phased in, or retroactive);
· Whether new IRS forms or worksheets are needed, whether existing forms or worksheets must be modified, and whether the effective date allows sufficient time for the IRS to prepare such forms and educate taxpayers;
· Necessity of additional interpretive guidance (e.g., regulations, rulings, and notices);
· The extent to which the proposal relies on concepts contained in existing law, including definitions;
· Effect on existing record keeping requirements and the activities of taxpayers, complexity of calculations and likely behavioral responses, and standard business practices and resource requirements;
· Number, type, and sophistication of affected taxpayers; and
· Whether the proposal requires the IRS to assume responsibilities not directly related to raising revenue which could be handled through another federal agency.

 

2. Role of the IRS in the legislative process

Congress must ensure that the IRS is the voice of tax administration and that it is directly included in the legislative process.

The tax legislative process is driven by revenue neutrality and progressivity estimates, but rarely takes into account the IRS ability to administer the tax law and taxpayersí ability to comply with it. Members of Congress generally are not informed as to the complexity of most legislative proposals. Because of political pressures against tax increases, Congress and the President often raise taxes by enacting cumbersome and impossibly complex rules, making it difficult for taxpayers to understand whose taxes are being raised, and by how much. Moreover, the constant incremental changes to the tax law have a significant negative effect on taxpayersí understanding of the law and the IRS ability to perform its mission effectively. Each tax law change, no matter how small, requires the IRS to reprogram its computers, retrain its personnel, and update tax forms, publications, and guidance. Taxpayer frustration, uncertainty, and cynicism increase as they are required to change their business practices and activities and reeducate themselves each year when they prepare their tax returns. These problems are exacerbated when Congress enacts changes without adequate time for public comments or comprehensive consideration of the legislationís practical implications and effect on taxpayers and IRS administration.

Although the IRS is involved in the legislative process at times, it does not have an independent seat at the drafting table and its most knowledgeable technical experts are rarely brought into the process. Treasury closely monitors and reviews interactions and communications between the IRS and Congress. While the Commission recognizes the importance of having one voice for the Executive Branch on tax policy, the Commission recommends that Congress hear an uncensored view of the administrability of all tax legislative proposals from the IRS.

To ensure that Congress understands how legislative proposals will affect taxpayers and the IRS, and to ensure that the Joint Committee on Taxation has adequate information to prepare a thorough Tax Complexity Analysis for each tax legislative proposal, Congress should require the participation of the IRS in the legislative process. For example, when the tax writing committees hold hearings to discuss specific tax legislative proposals, the IRS should be required to testify as to the administrability of each such proposal and to explain how each proposal will affect both taxpayers and the IRS.

 

3. Simplifying Tax Administration

Congress should simplify tax administration by limiting the assignment of non-core functions to the IRS, taking steps to improve cooperation between federal and state taxing authorities, and simplifying tax forms and publications.

 

Non-core functions

The purpose of the Internal Revenue Code is to raise revenue to fund the federal government for the benefit of the American taxpayers. Tax administration is complicated when Congress asks the IRS to perform functions that are not core to its mission of collecting the proper amount of tax at the least cost and burden to taxpayers. Congress often asks the IRS to use its substantial data capture and compliance capabilities for purposes not directly related to tax collection. While these diversions of IRS resources may increase overall government efficiency, they are not without cost to the IRS and the tax system. For example, when refund offset programs are used to collect child support or student loan payments, or when credits are added to the Internal Revenue Code to target a specific population already served by other federal agencies, Congress adds significant compliance and administrative burdens and runs the risk of undermining the IRS core capabilities and its nonpolitical nature. Similarly, when Congress asks the IRS to dedicate a greater share of its resources to help combat the war on drugs and money laundering, the result is fewer IRS resources to work traditional tax enforcement cases. The addition of non-core functions also further exacerbates the IRS governance and management problems, diverting the organization from establishing a strategic direction with clear priorities. With improved financial management information, the IRS should provide Congress with more accurate information as to the direct and indirect costs of requiring the IRS to assume non-core functions.

When the IRS may be uniquely qualified to administer a non tax collection function and Congress adds such a responsibility, Congress also should provide sufficient autonomy and resources. For example, in the Employee Retirement Income Security Act of 1974, Congress asked the IRS to regulate employee plans and exempt organizations. The EP/EO operation is recognized as one of the most innovative and efficient functions within the IRS. In recent years, EP/EO has developed a variety of programs to encourage voluntary compliance, including the voluntary compliance resolution program, the walk-in closing agreement program, and the administrative policy regarding self-correction. When created, the director of EP/EO was to report directly to the Commissioner with the authority to carry out the EP/EO functions as prescribed by the Secretary, and the operation was to have an independent source of funding. Recognizing that the IRS is organized to collect revenue, Congress enacted section 7802(b)(2) of the Internal Revenue Code to authorize an annual appropriation for EP/EO funding, measured by receipts of the excise tax on certain investment income. That funding mechanism has never been used, however, and EP/EO constantly struggles with the IRS core tax collection functions for resources to regulate more than $1.2 trillion in tax exempt assets and $1.7 trillion in retirement plan assets. To ensure that this non-core function of the IRS is able to continue its innovative and efficient approaches to regulating employee plans and exempt organizations, Congress should restore authority and utilize the specific appropriation mechanism.

 

Federal-State cooperation

Some of the complexity of tax administration could be ameliorated through greater federal and state government cooperation. Cooperative agreements between the IRS and state taxing authorities could improve the efficiency of tax administration at all levels by better utilizing resources and could reduce burden on taxpayers. For example, cooperative agreements for joint filing of federal and state returns and single processing of those returns, as well as joint examination and collection efforts and reciprocity of state refund offset programs, could simplify tax administration significantly.

One promising joint federal and state effort, the Simplified Tax and Wage Reporting System (STAWRS), was initiated to reduce burden on the nationís 6.2 million employers while improving the efficiency and effectiveness of federal and state operations. Because a business operating nationally must comply with as many as 189 different taxing jurisdictions, the STAWRS concept would provide significant simplification. However, the multi-agency approach for developing STAWRS has not facilitated progress. Meanwhile, several states have proceeded with their own initiatives. Congress and the IRS should proceed with the implementation of STAWRS in an effort to reduce taxpayer and tax administration burdens by harmonizing the wage code and providing a single point of filing for tax and wage reporting.

 

Tax forms and publications

While Congress often laments the complexity of tax forms and instructions, this complexity is a product of the laws written by Congress. The IRS coordinates the development of tax forms and instructions with its compliance, taxpayer services, communications, and legal advisors, as well as tax practitioner groups, to ensure that tax forms and instructions are streamlined and straightforward. Given the complexity of the law, most IRS forms and instructions are as clear and concise as could be expected.

Although the Paperwork Reduction Act has been a positive influence on the IRS by elevating the importance of burden reduction, the current presentation of taxpayer burden estimates on tax forms, instructions, and publications is meaningless and misleading to taxpayers. The actual time requirements depend on variables such as tax knowledge and experience of the taxpayer, and the complexity of the taxpayerís transactions. Ironically, the Paperwork Reduction Act can cause increased burden on taxpayers due to the manner in which paperwork burden is assessed. For example, each line on a tax form is viewed as increasing burden even though additional lines, such as a line to authorize a power of attorney, are of assistance to taxpayers. To ensure that taxpayer burden information is presented in a meaningful manner, Congress should require the IRS to publish a comprehensive estimate of taxpayer burden for the total population as part of its Statistics of Income reports, eliminating the requirements of publishing burden information on each tax form and document.

 

4. Other Simplification Proposals

Congress should take steps to ease the burden of tax administration on the IRS and reduce taxpayer frustration.

Over the past few years there have been increasing calls for tax reform. The impetus for this movement lies, in large part, with taxpayer frustration with the complexity of the Internal Revenue Code. The Commissionís mandate did not include the ability to evaluate the merits of the various proposals for fundamental structural tax reform. However, throughout the course of its work during the past year, the Commission heard from IRS employees at all levels, taxpayers, practitioners, and other stakeholders that the complexity of the law is a major problem.

As Congress and the President simplify the tax law, they should focus on features of present law that contribute to unnecessary complexity and impose unneeded burdens on the IRS and the American people. Appendix H highlights examples of issues that Congress and the President might consider in this regard, and provides a compendium of simplification proposals that the Commission received from various stakeholder groups and academics. The Commission forwards these specific proposals to the tax writing committees of Congress, without endorsement, and urges that they be considered.

In addition, to assure ongoing focus on the need to simplify the tax law, and to provide Congress and the President, as well as taxpayers, with the tools to pursue simplification, the Commission recommends that Congress explore the following ideas.

 

Quadrennial simplification process

Congress should explore developing a framework, similar to that established by the Congressional Budget and Impoundment Control Act of 1974, within which Congress and the President would consider tax simplification legislation through a regular process that is methodical, thoughtful, and that includes sufficient time for public debate, deliberations, and input from taxpayers and the IRS. The simplification process would require amendments to be revenue neutral, would prohibit inclusion of nongermane provisions, and would be subject to limited rules of debate. To ensure that this process includes taxpayers, Congress might consider establishing a commission of individuals that would develop recommendations that would be included in this debate.

To assist the commission leading the quadrennial review of the tax law, the Joint Committee on Taxation should undertake a review of the Internal Revenue Code using the Tax Complexity Analysis described above. Working with Treasury, the IRS, and taxpayers, the Joint Committee should review the tax law for provisions that may have outlived their original purpose or that have been superseded by other legislation.

 

Compliance burden estimates

Congress should explore the feasibility of developing a "baseline" estimate of taxpayersí compliance burdens. If these estimates can be developed, they would allow Congress to have a better sense of the impact of legislative proposals on taxpayers and on IRS resources. Future legislative proposals could be measured against such an analysis of these costs.

 

Establish one broad based tax system

Two of the most sweeping tax reform acts in history, those of 1969 and 1986, were not successful in their attempts to establish a truly broad based tax system. The result was the establishment and expansion of the Alternative Minimum Tax (AMT). The AMT, which is imposed in addition to the regular income tax, is intended to ensure that no individual or business taxpayer with substantial economic income can avoid significant tax liability by using exclusions, deductions, and credits. While the drafters of these rules were well intentioned, in reality the AMT affects many taxpayers who do not have substantial economic income, particularly because the AMT disallows many basic support preferences. For example, recent estimates by the Joint Committee on Taxation project that the number of individuals subject to the AMT will increase ten-fold from 1997 to 2006; this number will increase if recent proposals for child credits, education credits, and capital gains tax relief are disallowed for purposes of calculating the AMT. Moreover, the approach of the AMT, which layers a tax system within the existing tax system, is unnecessarily complex to achieve the goal of maintaining progressivity in the Internal Revenue Code. It imposes a tremendous burden on taxpayers and the IRS because it requires two separate calculations of tax liability, one for the regular income tax and one for the AMT. If the tax base was designed to be truly fair and comprehensive, there would be no need for a minimum tax. Because of the way Congress "scores" or calculates the impact of a change in the tax laws, eliminating the AMT would be costly in terms of revenue. To pay for its elimination, the Congress could consider other methods that would further the goals of progressivity that underlie the AMTómaking the tax base fair and comprehensive. If the Code is simplified so that taxpayers can understand it and so that it is truly fair and comprehensive, the necessity for any kind of AMT would be eliminated.