[Senate Hearing 114-164]
[From the U.S. Government Publishing Office]
S. Hrg. 114-164
TAX COMPLEXITY, COMPLIANCE, AND
ADMINISTRATION: THE MERITS OF
SIMPLIFICATION IN TAX REFORM
=======================================================================
HEARING
BEFORE THE
COMMITTEE ON FINANCE
UNITED STATES SENATE
ONE HUNDRED FOURTEENTH CONGRESS
FIRST SESSION
__________
MARCH 10, 2015
__________
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COMMITTEE ON FINANCE
ORRIN G. HATCH, Utah, Chairman
CHUCK GRASSLEY, Iowa RON WYDEN, Oregon
MIKE CRAPO, Idaho CHARLES E. SCHUMER, New York
PAT ROBERTS, Kansas DEBBIE STABENOW, Michigan
MICHAEL B. ENZI, Wyoming MARIA CANTWELL, Washington
JOHN CORNYN, Texas BILL NELSON, Florida
JOHN THUNE, South Dakota ROBERT MENENDEZ, New Jersey
RICHARD BURR, North Carolina THOMAS R. CARPER, Delaware
JOHNNY ISAKSON, Georgia BENJAMIN L. CARDIN, Maryland
ROB PORTMAN, Ohio SHERROD BROWN, Ohio
PATRICK J. TOOMEY, Pennsylvania MICHAEL F. BENNET, Colorado
DANIEL COATS, Indiana ROBERT P. CASEY, Jr., Pennsylvania
DEAN HELLER, Nevada MARK R. WARNER, Virginia
TIM SCOTT, South Carolina
Chris Campbell, Staff Director
Joshua Sheinkman, Democratic Staff Director
(ii)
C O N T E N T S
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OPENING STATEMENTS
Page
Hatch, Hon. Orrin G., a U.S. Senator from Utah, chairman,
Committee on Finance........................................... 1
Wyden, Hon. Ron, a U.S. Senator from Oregon...................... 2
WITNESSES
Markman, Carol, certified public accountant and director of
taxation, EP Caine and Associates CPA, LLC, Westbury, NY....... 5
Desai, Mihir A., Ph.D., Mizuho Financial Group professor of
finance and professor of law, Harvard University, Cambridge, MA 7
Bartlett, Bruce, former Deputy Assistant Secretary for Economic
Policy (1988-1993), Department of the Treasury, Great Falls, VA 9
Fogg, T. Keith, professor of law and director, Federal Tax
Clinic, Villanova University School of Law, Villanova, PA...... 10
ALPHABETICAL LISTING AND APPENDIX MATERIAL
Bartlett, Bruce:
Testimony.................................................... 9
Prepared statement........................................... 33
Desai, Mihir A., Ph.D.:
Testimony.................................................... 7
Prepared statement........................................... 38
Fogg, T. Keith:
Testimony.................................................... 10
Prepared statement........................................... 49
Responses to questions from committee members................ 54
Hatch, Hon. Orrin G.:
Opening statement............................................ 1
Prepared statement........................................... 58
Markman, Carol:
Testimony.................................................... 5
Prepared statement........................................... 59
Responses to questions from committee members................ 65
Wyden, Hon. Ron:
Opening statement............................................ 2
Prepared statement........................................... 67
Communications
Cole, Dixie Hickman.............................................. 69
Henderson, Martha................................................ 70
Johnson, Calvin H................................................ 72
(iii)
TAX COMPLEXITY, COMPLIANCE, AND
ADMINISTRATION: THE MERITS OF
SIMPLIFICATION IN TAX REFORM
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TUESDAY, MARCH 10, 2015
U.S. Senate,
Committee on Finance,
Washington, DC.
The hearing was convened, pursuant to notice, at 10:09
a.m., in room SD-215, Dirksen Senate Office Building, Hon.
Orrin G. Hatch (chairman of the committee) presiding.
Present: Senators Grassley, Crapo, Cornyn, Thune, Heller,
Wyden, Stabenow, Cantwell, Nelson, Carper, Cardin, Brown,
Bennet, and Casey.
Also present: Republican Staff: Chris Campbell, Staff
Director; Mark Prater, Deputy Staff Director and Chief Tax
Counsel; Eric Oman, Senior Policy Advisor for Tax and
Accounting; and Preston Rutledge, Tax Counsel. Democratic
Staff: Joshua Sheinkman, Staff Director; Ryan Abraham, Senior
Tax and Energy Counsel; Adam Carasso, Senior Tax and Economic
Advisor; and Michael Evans, Chief Counsel.
OPENING STATEMENT OF HON. ORRIN G. HATCH, A U.S. SENATOR FROM
UTAH, CHAIRMAN, COMMITTEE ON FINANCE
The Chairman. The committee will come to order.
I want to welcome everyone to today's hearing to discuss
simplification of the tax code. I also want to thank our
witnesses for appearing before the committee today and for the
written testimony that they have submitted.
This is the third hearing that the committee has held to
explore the principles of tax reform embraced by President
Reagan nearly 3 decades ago. Those principles were: efficiency,
fairness, and simplicity. We have held hearings on the
importance of growth and efficiency and of fairness in tax
reform. Today we will discuss the problem of complexity in the
tax code and the merits of simplification.
There are many sources of complexity in our tax system,
including a lack of clarity and readability; the use of the
Federal tax system to advance social and economic policies;
increased complexity in the economy; and the interaction of
Federal tax laws with State laws, other Federal laws and
standards, the laws of foreign countries, and tax treaties. The
proliferation of credits, deductions, exclusions, exemptions,
fees, and excise taxes, all of which were presumably intended
by their proponents for good, also add to the overall
complexity of our tax system.
Over the years, our tax code has grown to almost 4 million
words. Today, approximately 59 percent of American households
use paid preparers to do their individual income taxes, and
another 30 percent use tax software to assist them. Taxpayers
and businesses spend over 6 billion hours a year complying with
tax filing requirements, with compliance costs totaling over
$168 billion annually. That is larger than the entire economy
of New Zealand. That amount would employ more than 3 million
workers full-time at a wage of $25 an hour.
Wouldn't that money be better off in the hands of
hardworking taxpayers instead of devoted to complying with our
overly complicated tax code? Imagine a simpler tax code that
greatly reduces compliance costs, resulting in a tax code that
is efficient, effective, and accountable to taxpayers--in other
words, a tax code that Americans can actually understand.
As was noted in the comprehensive report on tax reform by
the Republican staff of the Finance Committee released in
December, simplification often gets overlooked or relegated to
secondary status in the tax reform discussion. That should not
happen. Complex tax provisions--such as the personal exemption
phase-out, or PEP, the overall limitation on itemized
deduction, or Pease, or the AMT--effectively force taxpayers to
seek constant help from professional preparers. Complexity
should be a matter of concern for tax policymakers because it
makes it more difficult, time-consuming, and expensive for tax
payers to comply with the law and for the IRS to enforce it.
Complexity also reduces perceptions of fairness in the tax
system and can decrease voluntary compliance with the tax laws.
But of course, simplification is not without its trade-offs.
For example, there is often a tension between fairness and
simplicity. Simple statutes may not be fair because they lump
together taxpayers who, in fairness, should be treated
differently.
Statutes that comprehensively address relevant distinctions
between taxpayers leading to fairness tend to be more complex.
But no one said tax reform would be easy. These tensions and
trade-offs come with the territory, but should not deter our
efforts.*
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* For more information, see also, ``Complexity in the Federal Tax
System,'' Joint Committee on Taxation staff report, March 6, 2015 (JCX-
49-15),
https://www.jct.gov/publications.html?func=startdown&id=4738.
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Today we will hear from four witnesses on the front lines
of the tax reform debate, and we look forward to discussing
with them the pros and cons of simplification of the tax code.
I am happy to turn now to the ranking member, Senator
Wyden, for his opening remarks.
[The prepared statement of Chairman Hatch appears in the
appendix.]
OPENING STATEMENT OF HON. RON WYDEN,
A U.S. SENATOR FROM OREGON
Senator Wyden. Thank you very much, Mr. Chairman. Mr.
Chairman, thank you for scheduling this hearing. I think this
is another important step in our effort to build a bipartisan
coalition for tax reform.
Mr. Chairman and colleagues, if you opened the hearing room
curtains and looked outside, you would see that the gloom of
winter is finally starting to lift. But instead of enjoying the
beginning of spring, millions of Americans are stuck, buried
under mountains of tax forms, documents, and receipts.
Around this time of year I start to hear from Oregonians
that they are sick and tired of this painful process of filing
taxes, and I am right there with them. Our tax system has
become so incredibly complicated, so byzantine, that even
someone who really knows their way around an accounting
textbook has a hard time getting everything right.
The fact is, our overly complicated tax code divides
taxpayers into very different worlds. There are the lucky few
who can afford to hire tax pros who can game the system--game
the system--with wash sales, option collars, and swap
contracts, activities detailed in a report that I released last
week. Then there is everybody else just trying to put their tax
return in the rear-view mirror. It is a whole lot harder to use
the code to your advantage if you are a middle-class person, a
small business owner, or a family just getting by.
For example, when a family needs help paying for higher
education, there are more than a dozen separate tax incentives
to wade through. As if that was not complicated enough, each
provision has its own set of rules and definitions.
The term ``small business'' is defined more than 40
different ways in the tax code. There are at least four
definitions of a dependent, which is what most of us know as a
child. Too often, simple errors on these and other tax breaks
aimed at the middle-class or low-income families are labeled as
fraud.
So, to avoid the hours and hours of paperwork, a lot of
taxpayers look elsewhere for help. Many turn to software
online, but they are often ending up spending a big chunk of
their refund just to file. As we learned this year, there is
often a security risk filing with software, so a lot of other
taxpayers look to return preparers. But that can also be a big
financial hit. Even worse, it exposes Americans to incompetence
and abuse by unscrupulous return preparers who do not have the
customers' best interest at heart. That is why Senator Cardin
and I introduced the Taxpayer Protection and Preparer
Proficiency Act to protect taxpayers by setting minimum
requirements of competence for preparers.
In the end, comprehensive tax reform provides an
opportunity to simplify America's tax system across the board.
Some say it is impossible for tax reform to make the tax code
simpler and fairer to all at the same time.
Colleagues, I just do not buy that. Simplification and
fairness are cornerstones of any serious tax reform plan. They
have been at the heart of the plans I developed with Senators
Gregg and Coats, Senator Coats now being a member of our
committee. Under those plans, which protected low-income and
middle-class families, most Americans would file their taxes on
a single 1-page form.
When the people up at Money magazine--and they know
something about taxes--tried it out, it took a matter of
minutes to complete a typical return, not hours. Now,
comprehensive reform is not going to iron out every wrinkle of
the tax code, nor should it.
But the experience taxpayers go through every spring does
not need to be such a horrendous nightmare. So let us look at
the effort that is under way, the bipartisan effort in this
committee, on tax reform. It is an opportunity to get people
out from under all this paperwork, and let us give springtime
back to the American taxpayer.
I look forward to discussing that with our witnesses today.
Thank you again, Chairman Hatch, for scheduling this hearing.
The Chairman. Well, thank you, Senator.
[The prepared statement of Senator Wyden appears in the
appendix.]
The Chairman. Our first witness today is Carol Markman. Ms.
Markman is the director of EP Caine and Associates CPA, LLC.
She began her own CPA practice in 1980, representing clients
before Federal and State taxing authorities for audits, and she
has served as a tax consultant and a partner in various
practices since.
Ms. Markman received her bachelor's degree in mathematics
from City College of New York and her master's degree in
accounting from LIU Post College of Management. Ms. Markman
served as a member of the Internal Revenue Service Advisory
Council from 2007 to 2010. She currently serves as a member of
the AICPA Tax Executive Committee and has served as the
president of the National Conference of CPA Practitioners. We
are very pleased to have you here today.
The next witness is Dr. Mihir Desai. Dr. Desai is the
Mizuho Financial Group professor of finance at Harvard Business
School and a professor of law at Harvard Law School. His areas
of expertise include tax policy, international finance, and
corporate finance. Dr. Desai received his bachelor's degree in
history and economics from Brown University, his MBA from
Harvard Business School, and his Ph.D. in political economy
from Harvard University.
Dr. Desai's professional experience includes working at CS
First Boston and McKinsey and Company. He is an award-winning
teacher at Harvard University, where he has built a second-year
elective on international finance management.
Our next witness is Bruce Bartlett. Bruce, we are happy to
welcome you back. He is a columnist and blogger for The Fiscal
Times and was previously a columnist for Forbes magazine and
Creator's Syndicate. His writing often focuses on the
intersection between business and politics.
Mr. Bartlett received his bachelor's degree from Rutgers
University and his master's from Georgetown. Mr. Bartlett has
served as a staff member for Congressman Ron Paul, Congressman
Jack Kemp, Senator Roger Jepsen, and the staff director of the
Joint Economic Committee.
Aside from his congressional experience, he was a Senior
Policy Analyst in the Reagan White House and Deputy Assistant
Secretary for Economic Policy at the Treasury Department during
the George H.W. Bush administration.
Our final witness is Mr. Keith Fogg. I am going to turn
that over to Senator Casey, who will make the introduction of
his fellow Pennsylvanian.
Senator Casey. Mr. Chairman, thank you very much. I am
honored to have the chance to introduce Keith Fogg. We are
grateful you are here with us today.
Professor Fogg is a professor of law at Villanova
University, one of the great law schools in the country. My
brother is a graduate, so I wanted to make sure my brother
Patrick Casey is on the record in that introduction.
Professor Fogg directs Villanova's Federal Tax Clinic, and
of course has great expertise in the area and the subject
matter of this hearing. He got his BA from the College of
William and Mary, his law degree from the University of
Richmond's T.C. Williams School of Law, and his LLM in tax also
from the College of William and Mary, in this case from the law
school, the Marshall-Wythe School of Law.
So, Professor, we are glad you are here. As a
Pennsylvanian, I am particularly honored to have the chance to
introduce you. Thanks very much.
The Chairman. Thank you, Senator.
We will now turn to Ms. Markman. You will be first here
today.
STATEMENT OF CAROL MARKMAN, CERTIFIED PUBLIC ACCOUNTANT AND
DIRECTOR OF TAXATION, EP CAINE AND ASSOCIATES CPA, LLC,
WESTBURY, NY
Ms. Markman. Good morning. As Senator Hatch said, I am
Carol Markman. I bet you could tell. For over 35 years, I have
specialized in taxation of individuals and small businesses. I
currently serve, as he said, on the Tax Executive Committee of
the AICPA, and I served as chair of the Tax Committee of the
National Conference of CPA Practitioners for many years.
Accompanying me this morning is Stephen Mankowski, the
current chair of the Tax Policy Committee for NCCPAP. Thank you
for the invitation to speak at this hearing on simplification
and tax reform.
Simplicity is a lofty goal in tax reform that many of us
would like to see. I have chosen to speak about tax
simplification related to four areas: retirement plans,
education incentives, modified adjusted gross income, and
allowable mileage rates.
With regard to retirement plans, there are many types of
retirement plans; the IRS website lists 15. Many taxpayers have
more than one type of plan when they reach 70\1/2\ and must
begin taking required minimum distributions from all of their
retirement plans.
One area of tax law that I think is ripe for simplification
is the rule requiring the taxpayer to withdraw a required
minimum distribution from each type of retirement account. This
begs the question: why is it necessary to take a required
minimum distribution from each type of retirement account?
Allowing taxpayers to take their entire required minimum
distribution all from one type of plan creates simplicity with
no reduction in tax revenue.
Another issue regarding retirement plans is the 10-percent
penalty on early withdrawal from a plan. There are 12 different
exceptions to the additional tax on distributions before age
59\1/2\; however, different exceptions to the penalty apply to
different types of retirement plans. It is my recommendation
that the penalty exceptions to the additional tax on early
distributions from retirement plans be made uniform across all
types of plans.
As Senator Wyden said, there are many incentives in the tax
law related to education which have different income phase-
outs, different limits on the number of years that benefit is
available, the number of courses the student must take, what
types of expenses qualify for the incentive, among others. Many
of the benefits are per family rather than per student, which
can be a significant issue for families with more than one
child in college at the same time. The phase-out of benefits
for high-income taxpayers should be made uniform across all
similar incentives, and there should be a separate phase-out
for taxpayers filing as head of household.
Currently, these taxpayers file and have the same phase-
outs as single taxpayers, but their family financial
circumstances are frequently very different. There is a need to
coordinate the various education incentives in order to
simplify these provisions. A computer should not be needed to
determine which education benefit applies and which ones will
produce the best result for a taxpayer.
Modified adjusted gross income. There are many definitions
of modified adjusted gross income that factor into the
preparation of individual tax returns. Modified adjusted gross
income is determined by adding back certain items to the
individual's adjusted gross income. The difficulty is
determining which items of income and deduction are added back.
I have identified 17 add-backs and items not taken into
account and two subtractions that are needed for one or more
modified adjusted income calculations. The varying definitions
greatly add to the complexity of tax return preparation so that
it requires a computer to calculate modified adjusted gross
income in many cases. It would aid in simplification if
modified adjusted gross income for similar provisions could be
made uniform.
For example, why are non-taxable Social Security benefits
an item that must be considered for Roth IRA contribution but
not for a non-deductible traditional IRA contribution when
neither type of IRA contribution is tax-deductible?
The last area concerns mileage allowances. There are
several allowable mileage rates available to taxpayers claiming
deductions in connection with business mileage, mileage to
obtain medical care, mileage when moving for a change of
employment, and mileage while performing charitable activities.
All, except the charity rate, are set annually by the IRS.
The charity rate was set by Congress in 1984 and has not
been changed in the last 30 years. Today that rate is
significantly lower than the rate for moving and medical care,
and taxpayers view this difference as unfair since many more
taxpayers can claim mileage for charity than can claim mileage
for medical care.
Thank you for the opportunity to present this testimony.
The Chairman. Well, thank you.
[The prepared statement of Ms. Markman appears in the
appendix.]
The Chairman. Dr. Desai?
STATEMENT OF MIHIR A. DESAI, Ph.D., MIZUHO FINANCIAL GROUP
PROFESSOR OF FINANCE AND PROFESSOR OF LAW, HARVARD UNIVERSITY,
CAMBRIDGE, MA
Dr. Desai. It is a pleasure to appear before you today to
discuss tax complexity. Excessive complexity in the tax code
has negative redistributive and growth consequences that have
only accelerated over time as more and more policy goals are
now implemented through the tax system.
My written testimony outlines how administrative and
compliance complexity retards efforts of policymakers by
reducing uptake, increases the likelihood that tax expenditures
lead to windfalls for taxpayers rather than to desired changes
in behavior, and redistributes wealth towards sophisticated
taxpayers and tax advisors who can manage this complexity.
Today I would like to emphasize how complexity arises and how
to address it.
Complexity arises from a call-and-response pattern of tax
planning by practitioners that provokes more detailed bright
line rules by administrators that in turn trigger new tax
planning opportunities, and so on. This death spiral of
planning regulation complexity is evidenced in the most
important area of business taxes, international tax rules,
where complex rules govern an unwieldy system that raises
little revenue.
As a recent example of this dynamic, last year's Treasury
notice, designed to prevent inversion transactions, will have
the primary effect of transferring wealth to foreign
multinational firms and those firms that inverted prior to the
proposed regulations, as they have become advantaged acquirers
of U.S. assets.
Indeed, several years of anti-inversion legislation and
rules have only served to increase the planning activities
around mergers and the real distortions undertaken to achieve
tax savings. Recent proposals to enact an Alternative Minimum
Tax on foreign-source income within a proposed territorial
regime provide the latest example of the vices of this planning
complexity dynamic.
Such proposals attempt to prevent planning by implementing
a de facto worldwide system of taxation without deferral at,
for example, a 19-percent rate on a per-country basis, but
label it a territorial regime. It would be preferred to
explicitly repeal deferral within a worldwide regime rather
than to enact such a back-door worldwide regime. Much as
today's worldwide system that functions as territorial is much
worse than a true territorial regime.
Such complexity creates numerous opportunities for planners
who have resources that far eclipse the ability of the
government to police them, and their efforts will trigger a new
round of regulations with further distortions and more planning
opportunities.
A simple territorial system, as implemented by governments
around the world with anti-abuse provisions and a simple
adjustment to address expense allocation, provides the best
alternative to ensure that the corporate tax system advances,
rather than retards, the interests of American workers and
firms.
Addressing complexity in the tax code requires analogizing
to other complex systems and drawing on the research that
demonstrates how to manage that complexity. In short, the
complexity of the tax code could be managed much as the
complexity of software code is managed.
This analogy yields two primary lessons. First, ``over the
wall'' engineering is highly problematic, and concurrent
engineering is preferred. Throwing completed ideas over the
wall to the next part of a production process limits learning
and engenders complexity relative to a concurrent and iterative
production process.
Currently, policy ideas are often developed without a clear
vision of the associated language and with even less attention
to the prospective administrators. The practice of policy
formulation and drafting must be a collaborative activity with
the administrative agency in charge of enforcement. More
consistently following and strengthening the recommendations in
sections 402(1) and 402(2) of the Internal Revenue Service
Restructuring and Reform Act would provide for a considerable
bulwark against creeping complexity by preventing over-the-wall
engineering.
Second and more radically, we could embark on an effort to
open up the administrative and legislative process in order to
effectively ``crowdsource'' the code. Currently, the code, to
the degree its complexity is managed at all, is managed much as
it was 50 years ago, in a fundamentally closed manner. Laws and
administrative guidance are drafted by small groups in a non-
transparent way that pays little attention to the overall
architecture of the tax system. As a consequence, vested
interests influence the management of complexity toward their
advantage, and complexity grows by ignoring interrelationships.
Effective management of complex codes, be it Linux or the
tax code, requires three steps. First, a code must be mapped so
that all the interrelationships, technically and conceptually,
of the different parts of the code become manifest; second, the
mapping enables modularization; and then finally,
modularization provides the foundation for opening up the code
to experts throughout society who contribute suggestions for
rationalization and simplification.
By mapping, modularizing, and opening the code and
associated guidance, we could draw upon widespread expertise,
provide transparency on the critical process, address the
imbalance of resources between the taxing authority and
sophisticated taxpayers, and begin the process of simplifying
the code and the associated administrative guidance. A modest
manifestation of the power of crowdsourcing ideas on the code
is provided in Appendix A, which compiles the suggestions of 20
experts on complexity.
Finally, three structural features of our tax system most
contribute to complexity. First, consumption taxes have major
simplification advantages over income taxes, as the base is
more readily identified, particularly given the growing
importance of cross-border flows of intellectual property.
Second, the reliance on realization events engenders great
complexity that could be alleviated by considering accrual
taxation in some settings. Third, the reluctance to embrace
solutions that provide taxpayers with the information that
taxpayer authorities already have, as with ReadyReturns, is a
major cause of unnecessary complexity in the individual arena.
Structural reforms that address these issues would allow for
considerable simplification.
I look forward to your efforts in this important area, and
I would be delighted to answer your questions.
The Chairman. Thank you.
[The prepared statement of Dr. Desai appears in the
appendix.]
The Chairman. Mr. Bartlett?
STATEMENT OF BRUCE BARTLETT, FORMER DEPUTY ASSISTANT SECRETARY
FOR ECONOMIC POLICY (1988-1993), DEPARTMENT OF THE TREASURY,
GREAT FALLS, VA
Mr. Bartlett. Thank you for the opportunity to testify once
again before this committee. Senator Grassley was the first one
to invite me here more than 30 years ago.
I speak not as a tax practitioner or as an academic, but
really more as an observer and occasional participant in the
tax legislative process, so I am just going to make some
general comments about the sources of complexity. One of them
is my observation that a lot of complexity is driven by the
need to get the tax distribution tables to look right.
Although I do not think it is a law or regulation or
anything, it is just sort of generally understood that if one
group is getting too much or too little, at the end of the day
you have to fix it somehow. Sometimes that requires coming up
with very convoluted ways of very narrowly targeting a tax
benefit or a tax penalty to some narrowly defined income group.
I do not know what to do about this. It is simply one of the
reasons why we have things like PEP and Pease.
Another point is that, just because people do not pay any
income taxes does not mean that they, per se, have a simpler
tax system to deal with than other people. The reason I bring
this up is because, when the 1986 Act was passed, President
Reagan was among those who hailed it for its simplicity. His
main point of data was, well, we are removing millions of
people from the tax rolls, therefore it is, per se, simpler for
them. I do not think that is the case for people who have to
deal with the EITC, which I gather Mr. Fogg will talk about.
Another thing is, I think when we talk about simplicity, we
talk a bit too much about the complexity of the deductions and
credits and things like that, but of course a lot of people use
the standard deduction or they have very simple deductions. The
growing complexity in the tax code or the tax process from the
point of view of the taxpayer, it seems to me, is coming from
the changing nature of the economy, which is changing the
nature of income.
More and more workers who used to get a simple salary are
now in effect independent contractors--Uber drivers, for
example--who are in effect small businessmen who now have all
of the complexity that goes with running a small business:
keeping track of all the records of expenses, having to
depreciate property, perhaps, and things of this sort that make
what appears to be a simple calculation of income actually
rather complex. This is a problem I have to deal with in my own
personal situation, which is why, for decades, I have had to
pay a tax preparer and cannot do my own taxes.
I would agree with Professor Desai that some type of
consumption-based tax system has at least the potential of
simplifying our tax system. I know that Senator Cardin has
introduced a bill to do something along those lines. I gather
it is based on the proposal that Professor Gratz at Columbia
has put together. I am very sympathetic to that.
It deals with a lot of the political problems of moving
towards a simpler tax system by simply making so much of the
tax system irrelevant for a large portion of taxpayers who
would simply pay their taxes by buying things. But this would
require putting in a value-added tax. I am well-aware of the
hostility to that in certain quarters, and I am certainly
sympathetic to that, but I think it is something we at least
need to talk about, because I think someday we are going to
have to deal with it.
I think in common conversation much, too much is made out
of the idea of trying to get to a single-rate tax system. I
think I testified before this committee around 1995 in favor of
the flat tax. I now think that it is not necessary to have a
single rate to achieve simplicity. I think the simplicity that
that achieves is grossly over-estimated. Like I said, I think
the growing problem is more in terms of determining income.
Let me just say I think that doing major tax reform,
tearing the tax system out by its roots and starting from
scratch, has an enormous amount of attraction. But I think that
in many cases it prevents us from doing stuff which is doable
now to just fix glaring problems in the tax code, which I am
sure the other witnesses will discuss. I just fear that we are
constantly putting off doing what is doable on a bipartisan
basis because we are holding that off to use for fundamental
tax reform.
I have a few other points I made in my testimony, but I
will stop there. Thank you, Senator.
The Chairman. Thank you.
[The prepared statement of Mr. Bartlett appears in the
appendix.]
The Chairman. Mr. Fogg?
STATEMENT OF T. KEITH FOGG, PROFESSOR OF LAW AND DIRECTOR,
FEDERAL TAX CLINIC, VILLANOVA UNIVERSITY SCHOOL OF LAW,
VILLANOVA, PA
Mr. Fogg. Thank you very much for inviting me to speak on
behalf of low-income taxpayers on how to make the system
simpler for them. I want to use a new client that I have to
illustrate how the tax system itself is complex for low-income
taxpayers. She is a woman of limited English proficiency. She
works in the health care industry and works through a temp
agency.
She met someone there while waiting to be assigned for a
job who told her she would help with the filing of her tax
return, so this friend took my client to a tax return preparer.
The tax return preparer took her information, had her sign a
form that shielded her from seeing the information on the
document, but told her that she would get a refund of
approximately $1,000 and it would come in a few weeks.
In a few weeks she had not received her refund. She could
no longer find the friend, and she could no longer find the
return preparer. After a few more weeks, she began to reach out
to the Internal Revenue Service to find out about her refund,
eventually finding out from the Internal Revenue Service that a
refund of $7,000 had been issued some weeks earlier.
At that point she went into a panic, which was logical, and
found another preparer. This preparer prepared an amended
return for her, properly claiming a $1,000 refund, but
unfortunately improperly using the amended return to do that.
Eventually the Internal Revenue Service began to match the
information from third parties with the documents that were
available on her return and determined that the return that was
filed was not entitled to a $7,000 refund. She got letters
eventually leading to her being assessed, eventually leading
her into the collection process, and eventually leading her to
our clinic.
But at this point in time, a woman who only makes around
$13,000 a year has not received her $1,000 refund for 2013. We
are advising her not to file her 2014 return because it will
just be taken to offset the liability now assessed against her
for 2013, and it is going to take a lot of work on the part of
my clinic and on the part of the IRS to correct this problem.
I want to talk about simplification in the return filing
process as a way to avoid this problem for many low-income
taxpayers. In our 2014 annual report, the National Taxpayer
Advocate, using statistical profiles of low-income taxpayers,
came up with findings that are not shocking, that they
generally have lower education, many have low English
proficiency, many are disabled, and many are elderly. These are
the types of people that my clinic deals with every day, and
these are the types of people who are having to encounter the
tax system many times because, 20 years ago, we decided to
deliver benefits through that system, through the Earned Income
Tax Credit.
So I want you to think about how the Earned Income Tax
Credit works and how refundable credit works in thinking about
how low-income taxpayers must interface with this system.
Because, while the Earned Income Tax Credit provides tremendous
and important benefits to low-income taxpayers and provides a
platform for efficient delivery of that, it also thrusts them
into a tax system which is very difficult for them to navigate.
Low-income taxpayers typically have significant
communication problems. My students have a lot of trouble
getting through to them. You can imagine the difficulties that
they have when trying to get through to the Internal Revenue
Service phone lines, which are tied up. My clients are
generally working during the day. They do not have easy access
to phones. A lot of them have TracFones, and, if they call the
IRS, they will use all of their minutes for the month just
waiting on hold.
There are very few walk-in sites now, so they cannot do the
in-person communication that they would prefer to do. The IRS,
because of staffing issues, is moving more and more to the
Internet. The Internet does not serve my clients well because
they are not able to process information through the Internet
the way that you and I could.
So the answer to this, for me, is to focus on getting the
return filing right, to stop focusing on getting the refund out
quickly and move to a situation with returns where the IRS
loads the third-party data before it processes the returns.
Bringing this back to my client, if that data had been loaded
before the return was processed, there never would have been a
$7,000 refund issued, the IRS would not be out $7,000, my
client would not have a $7,000 tax bill the IRS is trying to
collect, and we would simply be dealing with trying to get her
the $1,000 that she deserves.
Also engaged with this, and I know there are bills out
there dealing with this, is regulating return preparers. The
low-income taxpayers are the ones who generally fall prey to
the poorer return preparers, and I think that regulating them
would be a way to enhance the ability of low-income taxpayers
to properly get representation in their one touch with the
system. So we are very, very interested in that, and providing
a way for the IRS to provide walk-in assistance to taxpayers,
because they want that personal touch.
Thank you very much for allowing me to testify.
[The prepared statement of Mr. Fogg appears in the
appendix.]
The Chairman. Thank you. We appreciate all four of you
being here today.
Let me start with you, Ms. Markman. Your firm represents
clients in higher cost of living urban and suburban areas. Many
families in these areas have incomes that would make them
appear to have high income in many parts of the country, many
other parts. Because of the higher cost of living these
families face, they are probably closer to middle-income or
maybe even upper middle-income situations. The higher costs of
living are particularly evident in larger mortgages and higher
State and local taxes.
Now, those expenses tend to translate to itemized
deductions. Back in 2001, you were quite clear about the rules
that were in effect, the so-called Pease cut-backs, and the
complexity these hidden marginal rates brought to your clients.
In late 2012, the Nation confronted, as we all know, the fiscal
cliff, and, as a price for a fiscal cliff agreement, the White
House and its allies in Congress insisted on bringing back
these rules for single taxpayers at $250,000 and families at
$300,000. These income levels are national. They do not adjust
for cost of living variations among States and regions.
Now, Ms. Markman, for complex rules like the cut-back on
itemized deductions with its disproportionate impact in high
cost of living areas, isn't the best adjustment to eliminate
these rules? Can you see any justification for complex rules
that can hide marginal rates that zero in on folks in these
high-cost urban areas?
Ms. Markman. Pease and PEP exclusions make taxpayers very
angry. They have children, they have, as you said, real estate
taxes, mortgage interest. These are things that they know the
rule book says they are allowed to deduct, and yet, when we go
to prepare the tax returns, they are frequently phased out of
the opportunity to obtain the benefit of up to 80 percent of
their itemized deductions and frequently lose the benefit of
all of their exemptions.
There is an anger factor there. I mean, they understand
that this is how the law was designed, but the question is,
well, how did we get along without it for that period of time
and why was it brought back? You cannot explain that to a
taxpayer. All they know is that there is a benefit that appears
to be for them and yet they cannot use it.
Real estate taxes of $15,000 and $20,000 are quite common
where I practice. People have large mortgages because houses
are very expensive. The people who are significantly burdened
as well are those with large numbers of children. There is no
taking account for that. So from my perspective, and I think
from the clients' perspective, they would much prefer to see a
rate that is clear, that is transparent, rather than the
stealth rate because of these phase-outs.
Also, they ask me, what is my marginal tax rate? The answer
is, you cannot tell them because there are the phase-outs.
Phase-outs are frequently on top of other phase-outs. For
instance, medical is phased out for most people at 10 percent,
except if they are older than 65, and then it is at 7.5
percent.
Miscellaneous itemized deductions are phased out at 2
percent of adjusted gross income. So it is like piling things
one on top of the other. I think that is a simplification that
is definitely worthy of consideration.
The Chairman. Well, thank you.
Dr. Desai, you stated in your testimony that last year's
Treasury Department guidance on inversions and several years of
anti-inversion legislation and rules ``have only served to
increase the planning activities around mergers and the real
distortions undertaken to achieve tax savings.'' In that vein,
you referred to these rules and regulations in the context of
the ``death spiral of planning regulation complexity.''
Now, I am very concerned that the path the administration
is taking on international tax changes, particularly with the
imposition of an anti-competitive 19-percent minimum tax, will
only continue this death spiral, particularly in the context of
inversions, as more U.S. companies make plans to invert and
Treasury releases more regulations and guidance to prevent it.
Now, if the United States were to adopt the international
tax proposals, in particular the 19-percent minimum tax
included in the President's latest budget, do you foresee an
uptick in planning regulation complexity due to the increased
desire by U.S. firms to invert, and what is the best path
forward to prevent this death spiral of planning regulation
complexity in the inversion context, and will a territorial
type of tax system help? That is a lot of questions.
Dr. Desai. Well, I will take my best shot. So I think there
are several things to say. First is to realize that, in this
setting, there is a great mismatch between the abilities of the
IRS and the taxpayer, so these corporations are very
sophisticated. They are going to invest huge resources to
achieve their goals.
So one should always keep an eye on that when one is
designing international tax rules, because there is a
fundamental mismatch in resources, which is not true across all
the different taxpayers we are talking about.
So the second thing to say about the minimum tax is to make
sure we understand it as what it is, which is repealing
deferral in a worldwide system. That is what it is. I think
what is difficult about the proposals is that they label it
territoriality but effectively they are repealing deferral.
The Chairman. Right.
Dr. Desai. So we should understand first off that that is
what it is, it is a worldwide system with a repeal of deferral
at a 19 percent rate.
Then the third thing to say about that is to just realize
that that decision to go in that direction is fundamentally at
odds with the way the rest of the world has gone in the last
several years. And as a consequence of that, it becomes very
difficult to become an American acquirer of U.S. assets, it
becomes difficult to become an American acquirer of foreign
assets, and it becomes very nice to be a foreign acquirer of
American assets.
So that is the fundamental nature of what that trade-off
yields. That, in turn, is problematic, because American
companies, when they expand abroad, tend to expand
domestically. American managers who belong to American
companies do well when their firms expand abroad. American
workers who are part of multinational firms that grow abroad
are going to benefit from that, so fundamentally it works
against all those.
What would I expect to see if that were to happen? I would
expect to see more of what we see now, which is not inversions
in a pure sense but something maybe much more destructive,
which is, (A) multinational firms making themselves smaller by
splitting so that they can be acquired by foreign companies.
Under the recent regulations, in short, you need to get smaller
so that you can be bought up by someone else, because that is
the way the rules work--a very perverse consequence.
Then, second, you can expect more foreign buyers and the
people who got in under the gate of September, whatever it was,
to become really good acquirers of companies. That all is
unfortunate. So I think the way forward is somewhat
straightforward. The way forward is to think about a simple
territorial regime, a real territorial regime as enacted around
the world, which has a rate that you apply to domestic income
but then tries to get at expense allocation and abuse in
traditional ways, as opposed to what is effectively a back-door
way of doing it.
The Chairman. Senator Wyden?
Senator Wyden. Thank you very much, Mr. Chairman. This has
been an excellent panel. I am, Dr. Desai, going to pass on the
temptation to get into the territorial issue because I want to
see if we can find some common ground as it relates to
individuals.
Now, last week I put out a report here in the Finance
Committee that looked at some of the most recent and some of
the most offensive of the tax loopholes. We looked at wash
sales and option collars and swap contracts.
Suffice it to say, there is kind of a bundle of these tax
provisions that eliminate a substantial amount of investment
risk, and the people who can take advantage of it pay half the
tax rate. That is pretty much what goes on. They pay half the
tax rate of people who just punch a time clock every day and
have their taxes automatically taken out of their paychecks.
So at that point it seems to me there is a disparity in
terms of fairness. In other words, the middle-class person just
has it taken out of their paycheck, and, if you are able to
hire all these sophisticated tax pros, you can take advantage
of the things that I described in the report.
But in addition to the disparity in fairness, there are
other problems, because what happens as a result of
sophisticated pros being involved and trying to use every
possible tax shelter is, we end up with a whole lot of
additional tax complexity, because the Treasury Department
says, oh my goodness, we have to limit all these shelters and
all the damage that they are doing. So then we have more
complexity and more expense associated with trying to deal with
these shelters.
Yet, despite the shelters, what my report found was that
sophisticated taxpayers with all these pros can still game the
system, and this costs the Treasury billions and billions of
dollars.
So my question is as follows. Maybe I will just go right
down the row, starting with you, Mr. Fogg, but I would like to
get everybody. A few weeks ago, sitting where all of you are,
was a Republican and a Democrat. They were the architects of
the 1986 tax reform bill. In the 1986 tax reform bill, they
equalized tax rates for income from wages and income from
investments. They said, you ought to do it again. They said it
made sense in 1986, and it makes sense now.
The question I have for each of you is, and let me just
maybe go right down the row, how much of this tax compliance
and enforcement headache and complexity and time and money, how
much of it, in your view, would in effect diminish or maybe
even go away in some particulars if we said in America, like a
group of Democrats and a group of Republicans did in 1986, we
are going to make the tax rate the same for income from wages
and income from investments?
Let us just go down the row. Just an opinion about
complexity. I know we will have people having differences of
opinion on the merits, but just an opinion on the complexity.
Would it be less of a headache, less of a compliance burden?
Let us go down the row: Mr. Fogg, Mr. Bartlett, the rest of
you.
Mr. Fogg. All right. You know that for low-income taxpayers
it is not much of an issue, the difference. They do not have
much in the way of investments. But I think that you could
reduce complexity by making the rates the same for both. I know
there are reasons not to do that, but yes, I would agree with
that as a general principle.
Senator Wyden. Good.
Mr. Bartlett?
Mr. Bartlett. The big problem with capital gains is that
the taxpayer chooses when, or if, to realize that income. So
income from capital gains and from ordinary income are not
symmetrical. This is the historic problem with capital gains
dating back to the 1920s: if you raise the rate on capital
gains to the ordinary income rate, people will simply not
realize capital gains, and you have what is called the lock-in
effect. This is the reason why, historically, there has always
been a lower preferential rate on capital gains.
Now, I think this is a very serious problem, this
realization principle that I think would be desirable to get
rid of if there was some way to do this. The way they do it in
Europe, in some countries, is they have what is called a dual
income tax, where they have income that goes into what they
call boxes.
The one system I have looked at is, I believe, the
Netherlands, where capital gains all go into a particular box
and they assume an imputed rate of return on which you pay
taxes. But it is completely unrelated to whether you realize
gains or not, so you can buy and sell all you want to without
having to worry about whether you are realizing taxable capital
gains. I think trying to do something along those lines might
be the way out of the problem of the fact that capital gains
are just fundamentally different from ordinary income.
Senator Wyden. Dr. Desai?
Dr. Desai. I think you are absolutely right, Senator Wyden,
to focus on these issues. I think they are paramount to
understanding complexity. Of course, the most major
manifestation of that is the way carried interest is treated
generally.
I would say about a third of it is the disparate rates, and
I think two-thirds of it is the realization doctrine that I
mentioned in my testimony as well. So those are the two
fundamental roots of it, and I think the lion's share of it is
coming from the realization principle.
Ms. Markman. The 1986 Act did create simplicity, but at
what expense? It introduced the whole concept of passive
activities and passive activity losses and greatly impacted at
the time the entire real estate industry, which we saw very
clearly subsequent to 1986, where real estate became this bad
activity because, if you did not actively participate in it,
then you were not entitled to claim your losses.
The losses were real, but you could not claim them because
they were considered passive activities if you were not
actively engaged in it. So there was a price to pay, and it
created its own element of complexity. Also, the carried
interest rule. Why is carried interest considered capital gains
today? That does not make any sense from where I sit.
The other thing that I think is an unfairness and looks at
the whole issue is the 1031 gain issue, that you can postpone
the gain on the sale of property simply because you reinvested
it in other property, but only if it is business property. I
mean, there are a whole bunch of issues there that I think
create another level of complexity.
Senator Wyden. My time has expired. I just want, on the
point you made with respect to real estate, I can tell you a
bipartisan majority here on the Finance Committee does not
believe investment in real estate is evil, and you can see that
by the bill that we just passed, the Real Estate Investment and
Jobs Act.
Ms. Markman. I am saying that that was the result of the
1986 Tax Act.
Senator Wyden. Well, there are a lot of Senators here who
have gotten the drift.
Thank you, Mr. Chairman.
The Chairman. Thank you.
Senator Carper?
Senator Carper. I think Senator Casey might have been here
sooner, so, if that is the case, I should yield. I want to stay
on his good side.
The Chairman. That is not what I have, but I would be happy
to go to Senator Casey.
Senator Carper. Thank you, though.
Senator Casey. Well, thanks, Senator Carper. I am not sure
what I owe him now, but I am sure it will be something
substantial. [Laughter.]
Mr. Chairman, thank you and the ranking member for having
this hearing. I want to thank our witnesses for your appearance
here and your testimony, as well as helping us better
understand these issues.
In particular, Professor Fogg, I want to focus on some
questions that you have raised, and in particular I also wanted
to thank you for the example you provided in your testimony.
Sometimes it is best to tell the stories or to illustrate these
problems or challenges through the story of a real person and
the folks who do not have economic power, who are sometimes not
able to navigate the tax code as some others who have greater
means.
I wanted to focus, first, on what is a difficult tension, I
guess: the tension between making sure the refunds go out as
quickly as possible versus making sure that the IRS can do its
job to identify instances of fraud.
On the one hand, delaying refunds could help the IRS
identify those examples of fraud before issuing refunds, and,
on the other hand, delaying is disruptive to that individual
who may have to pay, as you cite in your testimony, a utility
bill or some other immediate need in their life.
So I wanted to focus in a particular way on some of the
recommendations that you made to mitigate the impact of
delaying refunds on tax returns. If you could just kind of walk
through some ways to mitigate that problem.
Mr. Fogg. I think that, for the most part, it may be a one-
time problem. I mean, we have created a system where people
expect their refunds early in February. I mean, particularly
for people who have a large refund who are at the door when the
IRS opens the door for tax returns, they are filing and they
are hoping for a refund very quickly in February.
We have a lot of industries that are pegged toward those
people getting refunds then. I think utilities is one where we
really have to think about it and work it out, because the
money is coming at a time when many of my clients need the
money to pay their heating bills. So there has to be some way
to work with the utility companies. That kind of bill is one
that is being postponed until a critical point and needs to be
paid, and I understand the difficulties that it will create for
my clients if you delay.
Once you delay in the first year, we have just created a
different cycle for people to deal with on taxes. I mean, we
almost have this Circadian rhythm of where we are today, but it
does not have to be that way. I mean, it could be that we get
used to getting our refunds in April or May rather than in
February and March.
What I am suggesting is that, to make the system work for
low-income taxpayers and not cause them to get caught up in the
back end of the system, if the IRS could get the data quicker,
load the data, and have it when people are filing their
returns, they will be able to determine which returns are bad.
I think that will drive the identity thieves and the fraudulent
preparers out of the system, because they will no longer be
able to get the money as quickly and easily as they get it
today.
Senator Casey. I guess, if you had to do a profile of your
typical client, what is that basic profile, the low-income
clients that you have?
Mr. Fogg. About half of my clients who are coming in are
dealing with the IRS on whether they owe the tax, and about
half of my clients already do owe the tax when they come to me,
so we are dealing with how to deal with the IRS on the payment
of the tax.
So, if I am looking at my client and we are determining
whether they owe it, it is frequently an elderly couple or
elderly individual or a single mother who has children whom she
is dealing with and has claimed the Earned Income Tax Credit.
If the Earned Income Tax Credit is involved, it is
frequently somebody who has claimed the credit and been denied,
probably because the dependents have been claimed by someone
else, and that other person claiming the dependents may have
claimed first.
Right now there is a race to file your tax return because
the first person in gets the refund for that child, so, if you
are the second person in, you get denied and you have to then
work through the whole back end of the IRS system. So that
client is the one whom I am concerned about, because frequently
my client is not the first one in, they are second in, so they
are being tossed into the IRS compliance system, all because
somebody wrongfully claimed the child before they did.
So that is a typical client. So they are not getting their
refund, which could be $6,000 or $7,000, which could be a third
of their income for the year, and then they may not get it for
a couple of years by the time they fight through the IRS
system, not that the IRS is doing anything wrong, but that is
just the way the compliance system works once you are caught up
in the system of having to fight over your refund. And, if you
end up in court, it takes even longer.
Senator Casey. Thank you very much. Other members of the
panel, thank you.
The Chairman. Thank you, Senator.
Senator Cantwell?
Senator Cantwell. Thank you, Mr. Chairman. Thank you,
panelists. I have been to several other hearings, Mr. Chairman,
and I have always wanted to ask this question but time has not
allowed. So I am not even sure that you are the right panel for
this question, but if people want to weigh in----
My general question, and then I have a specific question
for Mr. Bartlett, is just, when I look at our discussion of tax
reform, and so much is centered around the competitiveness of
industry as it relates to what is happening on a global basis
and the fact that they have to reduce their corporate rate, I
look at it and say, isn't the bigger issue that we are in an
innovation economy, and what is the best tax code to take
advantage of that innovation economy, to make the right
investments, and to grow the opportunity within that innovation
economy?
Dr. Desai, I guess I kind of like your software approach to
the tax code and your suggestions, because at least you are
thinking about some of the advantages there as it relates to
that.
So my question, the broad question, if anybody wants to
weigh in on it, is just, shouldn't we be thinking about this as
it relates to the growth opportunity in GDP and how we best
harness that growth opportunity? So having a tax code that
basically fits an innovation economy and takes advantage of it
is what it is going to take for us to compete, which again
means investing in research and development and the skill level
of the workforce and what have you.
One of the very specific issues, though, Mr. Bartlett--and
I have read your books, and thank you for all your columns. I
think it has been very helpful to have this kind of discussion
in the broad public. I wish we could do more of it. I do not
know if that means you are writing another book in the future,
but certainly I would sign up to read it.
But is this issue of where we are with retirement savings
and annuities--I just feel that we are so far behind with where
the public needs to be in savings. We have looked at having
annuity legislation here as a way to further incent people
making investments in their retirement that would pay out at a
better scheme. So specifically about annuities in an innovation
economy----
Mr. Bartlett. Well, as you know, for quite some years, at
least since 1978 when the Keogh plan was invented, we have been
transitioning from a defined benefit-type system to a defined
contribution-type system, and more and more the burden of
retirement saving is simply on the individual.
Certainly anything that can help people prepare for
retirement is all to the good. I am not sure precisely how that
relates specifically to an innovation economy, except insofar
as I pointed out earlier that more and more people are being
forced to become independent contractors in our economy.
One of the benefits, frankly, of being an independent is
that you have more options available for retirement savings
and, to a certain extent, tax sheltering of those savings. But
entrepreneurial incomes vary, and people may be forced to take
money out of retirement accounts and get into the whole penalty
situation.
The one thing I would mention specifically with regard to
innovation is to please make the R&D credit permanent. See, it
does not actually do any good the way it exists because, if you
are making and planning an investment in technology that would
qualify for the credit, you are probably planning years down
the road, and your accountant is going to say, we cannot build
that in to the rate of return because we are not sure it is
going to be there down the road when we would have the
investment that we would claim the credit for.
So it just ends up being a reward for things that companies
would do anyway, so what you have to do if you want it to work
to increase net new incremental investment is, you have to make
it permanent.
Senator Cantwell. Thank you.
Dr. Desai?
Dr. Desai. I was just going to mention briefly, I think you
are absolutely right to focus on this. I think if you were
thinking about this, you would think about three things. The
first is underlying sources of innovation. You have to think
about education, and so you would want to think about education
incentives which are massively complex and under-utilized.
Second, you would want to think about the R&D tax credit and
making it simpler and permanent. Then the third thing on the
international scene is, as you may be aware, everybody wants
R&D. Everybody wants this, so countries have gotten very
aggressive, and now they have patent boxes, which are
effectively a little specialized tax regime for intellectual
property. So, come to our country, put your patent there and
put some scientists there, and we will give you a really low
rate, like 5 or 10 percent. So I think that should inform our
broader corporate tax debate, because these countries are
getting patent boxes for exactly the reason you want, which is,
they are for R&D. So our system has to be something that at
least provides an alternative that is as good as that.
Senator Cantwell. Well, we have had some testimony on this,
and I think we have to expound on it more, what other countries
are doing with their patent boxes. But thank God, innovation is
in the American DNA and cannot be easily transferred, as much
as other countries want to. But you still have to put the input
into education and job training and all the things that go
along with that innovation.
Thank you. Thank you, Mr. Chairman.
Senator Thune [presiding]. Thank you, Senator Cantwell.
Senator Cardin?
Senator Cardin. Thank you, Mr. Chairman. Let me thank all
the witnesses today. Mr. Bartlett, thank you for your comments
on the progressive consumption tax. At the last hearing, we
were dealing with fairness, and I went through how we could get
better fairness in tax reform and went through the advantages
of a progressive consumption tax. This is on simplification. We
could talk about competitiveness, trying to get marginal rates
that are competitive globally. As long as we rely solely on
income taxes, we will never get competitive marginal rates on
the international front.
Or we could talk about rewarding savings, because America,
even in the best economic times, had low savings ratios, and in
some cases we had negative savings ratios during periods of
economic expansion. A consumption tax rewards savings. Or we
could talk about international trade and the rules of the WTO
and what is border-adjusted.
But I want to get your response on the simplification
issues and the advantages of moving away from solely income
taxes or primarily income taxes to looking at a progressive
consumption tax. I want to focus on a couple specific points.
One, it seems to me it is easier to identify consumption than
it is income. One of the issues on simplicity is that people
want to know that they can figure out their tax liability.
So the first issue I would just like you to concentrate on
is, on the matter of simplification, wouldn't we be better off
using an entity for taxation that is easier to define, such as
consumption, rather than income?
The second point, and then I will give you a chance to
respond to this, is that, in the proposal that I brought
forward, you have a lot fewer taxpayers. There is no income tax
liability for families with taxable income below $100,000. That
eliminates a lot of your income tax returns, certainly
simplifying things. Of course, far fewer people pay consumption
taxes, collected consumption taxes, so you get fewer taxpayers.
The third is that we simplify the personal income tax by
having only four major deductions from it for State and local
taxes, charitable contributions, interest on mortgages, and
benefits that employers pay.
So concentrating on simplification, because that is today's
hearing topic, I would like to get your reply as to whether you
think that moving towards a consumption tax would in fact
simplify the tax code from the point of view of American
taxpayers, and whether you believe we should be moving in that
direction. I will start with Mr. Bartlett.
Mr. Bartlett. Well, certainly having a consumption tax
offers the potential of massive simplification. You could
eliminate a lot of people from not merely having to pay taxes,
but having to even keep any records. The problem we have always
had is that the term ``value-added tax'' always comes up as
soon as you bring this issue up, and that is considered the
devil's work, or something, I do not know. There are a lot of
people who are just very afraid of that term.
Senator Cardin. A lot of people are afraid of taxes too.
Mr. Bartlett. Well, that is true too. But there is a school
of thought that some economists have, which is that it is good
to make tax-paying as difficult and painful as possible
because, that way, there will be a political incentive to keep
the tax burden down. I think that is ludicrous, but there are
people who have written articles in respected academic journals
making that point.
I would just say that every other major country has a
national consumption tax of some kind. We are the only one that
does not. Having that as a revenue source would potentially--we
could do so much simplification with that. We could eliminate
deductions and credits and reduce rates and make tax credits
like the R&D credit permanent. There is enough revenue there.
The last time I thought about it, you could get something like
$50 billion a year per percentage point from a broad-based
value-added tax.
One of the great things about it is that it improves
competitiveness, because the corporate income tax is not
rebatable at the border, as you know, and the value-added tax
is. If we replaced the non-rebatable tax with a rebatable tax,
that, per se, improves competitiveness. There are just so many
good arguments for it, it is sad that we cannot have----
Senator Cardin. I just want to point out that the bill that
we filed uses a credit method so that you get full credits for
all the taxes that you have paid in the production chain, so
you get uniformity of collection, but you also get fairness
from the point of view of what you have to pay and do not
double pay.
My time has run out, but I see that you are anxious, so
please.
Ms. Markman. The sales tax is a very simple consumption
tax, but it is the most regressive tax because it affects
people least able to pay.
Senator Cardin. If you use----
Ms. Markman. You have to craft it----
Senator Cardin. Just so you understand, the bill that I
filed provides credits for low-income families based upon size
and income. So you have a card that you use, as we currently
have for certain government benefits. You would use that card
as you purchased your item, so if you had low income or a
certain family size, you would not pay the consumption tax.
Ms. Markman. Would it affect what people decide to do? If
you had two people who were single, would they decide not to
get married because they would then be affected by this income
threshold that you would have created where, above that, they
would be subject to the tax? I mean, there are a lot of
societal issues.
Senator Cardin. That is a good question on marriage
advantages or penalties. I know we have that under our current
tax code. Your status is much more determinative of your income
tax liability than it would be your sales tax liability. It is
very difficult to avoid consumption. You can manipulate income,
but you cannot manipulate consumption.
Ms. Markman. To a certain extent. You can choose not to
buy, however.
Senator Cardin. Sure.
Thank you, Mr. Chairman.
Senator Thune. Thank you, Senator Cardin.
Senator Brown?
Senator Brown. Thank you, Mr. Chairman. Thanks to Senator
Hatch and Senator Wyden for holding this hearing.
Mr. Bartlett, I would like to ask you a couple of
questions. You testified that it is especially hard to cut tax
rates without disproportionately benefitting the wealthiest
taxpayers. It calls into question the wisdom of continuing to
chase comprehensive tax reform modeled after 1986.
In my mind, there seem to be two alternatives. The first is
to wait until the political dynamics change and we can explore
new sources of revenue. The more preferable, I think, of the
two alternatives and the more realistic possibility is that we
abandon this quest to recreate comprehensive tax reform and
instead focus on a set of discrete packages of reform.
I think the chairman's request and follow-through with
Senator Wyden on setting up these five or six working groups
with one Republican, one Democrat sort of co-chairing them as a
forum for teeing up this kind of reform, particularly in the
areas of international corporate taxes and retirement savings,
is a good start.
Mr. Bartlett, if you would, walk through how a piecemeal
path to reform could work in your mind and offer your thoughts
and advice on how we proceed.
Mr. Bartlett. Well, let me make a point about the 1986 act,
because that is always the guidestar for trying to start with
tax reform. The problem with the 1986 Act is that it was
basically a tax increase on corporations. That revenue was then
used to both simplify and reduce taxes for individuals.
The problem now is that all the political and economic
pressure is to cut rates for corporations, but there are not
enough deductions or tax expenditures on the corporate side to
finance a meaningful reduction in rates just on the corporate
side.
So, if you want to get the top rate, the corporate rate,
down to, say, 25 percent, which is the number I keep hearing,
you have to get some additional revenue from the individual
side. So, in effect, you are going to have to raise taxes on
individuals to cut taxes for corporations, and I think that is
impossible politically.
So that raises, again, the idea of putting a new revenue
source on the table that could finance a reduction in the
corporate tax rate. I do not know if that answers your
question.
Senator Brown. Well, it answers the first part. But give us
more thoughts on how we would sort of do this piecemeal then,
where you would like to see us go.
Mr. Bartlett. Well, it seems to me if you talk about the
things that Mr. Fogg, Ms. Markman, and others have discussed,
there is a lot of simplification that could be done in a pretty
revenue-neutral, or even de minimis revenue fashion. I would
like to see that done just to show that it can be done.
I think it has been a long time since there was a big tax
reform bill, and I think Congress needs to--there are very few
members here left who went through any of those previous
processes in 1969, 1976, or 1986. I think you need to crawl or
waddle before you can learn to walk, and we have to start
somewhere.
Senator Brown. All right. Thank you.
The President has proposed a 19-percent minimum tax that is
not dissimilar to what was proposed by Chairman Camp. Would
that proposal reduce complexity? Would it increase complexity,
would it reduce compliance, would it increase compliance? Talk
that through for us if you would, Mr. Bartlett.
Mr. Bartlett. Well, Professor Desai is actually the expert
on that. I would defer to him.
Senator Brown. Well, I would like to hear your thoughts
first, then his.
Mr. Bartlett. I honestly do not know whether it would
improve simplification, but then again the international side
of our tax code is so complicated it is hard to make it more
complicated, so it would probably help to some degree.
Senator Brown. And compliance. Thoughts on compliance, or
no?
Mr. Bartlett. Well, certainly economists assume that the
higher the rate is, the more incentive there is to evade or
avoid taxation, so lower rates, per se, improve compliance.
Senator Brown. Dr. Desai?
Dr. Desai. I was just going to mention briefly, I think if
one has that policy goal, then one should just stay in a
worldwide regime and repeal deferral, and then compliance could
be better. Whether that is actually in the interest of the
country is a different question, and, as my testimony suggests,
I do not think so.
I just wanted to address one other thing about the business
side, which is, I think there is revenue, and I think it is
largely in the scope of kind of pass-through entities. So if
you wanted the revenue on the business side, the place to find
it is in the massive growth of pass-through entities and
addressing that, because that could actually generate a lot of
revenue.
Senator Brown. All right. Thank you.
Senator Thune. Thank you, Senator Brown.
Senator Carper?
Senator Carper. Thank you. Great to see you. Thanks for
your testimony.
Mr. Fogg, our youngest son is a William and Mary graduate,
a proud William and Mary graduate, so I especially want to give
you a warm tribe welcome here. That is from a guy from the Blue
Hen State. But it is nice to see you all. Mr. Bartlett, nice to
see you again, and others too.
Sometimes when you have a panel of brilliant people like
this who do not have the same views on tax simplification, I
like to ask, what do you agree on? I think it would be helpful
for us as we try to develop consensus. Where do you see some
common ground? Because we have to develop that here. Maybe you
could help lead us in that direction.
But, Mr. Fogg, where are a couple of areas where you think
this panel actually agrees on tax simplification?
Mr. Fogg. We have talked on so many diverse things, I do
not know that we have even talked on the same thing. I mean, I
think particularly if you go to pass-through entities, for me
that appears to be an area where there is a lot of ground that
could be made up in collecting revenue. So, I would definitely
agree with that comment as a place to look for simplifying and
maybe gathering more revenue.
Senator Carper. All right. Thank you.
Go ahead. If you have another one, go ahead.
Mr. Bartlett. I think we would all agree that it is a bad
idea to have so many different incentives for more or less
exactly the same purpose. Retirement and education are two
areas that come very much to mind.
Senator Carper. Why do you suppose we have so many? That is
a good point.
Mr. Bartlett. Well, because somebody gets an idea, they
pass a bill, and they want it to be the Cardin bill or the
Thune bill, and so they have an incentive to kind of have a
proprietary interest in getting their legislation enacted in
its own form. The former chairman of this committee, Mr. Roth,
has something named after him, the Roth IRA.
Senator Carper. There is a bridge in Delaware named after
him too. I authored that legislation. [Laughter.]
Mr. Bartlett. So I think sometimes people are just myopic,
and, when it comes time to do these things, it is easier to
just enact a separate standing bill as is rather than work
harder to integrate it into the existing tax system, perhaps. I
do not know.
Senator Carper. All right.
Dr. Desai?
Dr. Desai. I was just going to mention two things. One is,
I think there is broad agreement about unifying, as Bruce
suggested, retirement and education. I think that is clear. I
think Mr. Fogg's idea about providing information that the
government has to taxpayers is brilliant, and I think
ReadyReturns is a great example of that.
I think the reason we do not do it is because there are
powerful interests who do not like that idea, namely the tax
preparation industry. But I think it is a fantastic idea and
would help low-income folks, but actually would almost help
everyone if the IRS were to send the information they have to
the taxpayer. That would be the foundation of a return.
Senator Carper. All right. I have been in and out of the
room, at other meetings, in the adjoining room. I may have
missed that point. I will come back to you and ask you to drill
down on that, Mr. Fogg.
Ms. Markman?
Ms. Markman. In light of what we talked about, what Mr.
Fogg talked about, the question is, why does W-2 data go to
Social Security first and IRS second? Why can't it go to both
at the same time? A lot of the problems that his clients have
are a result of the IRS not getting the information in a timely
manner. It is delayed. Usually the IRS does not get withholding
information until late spring or early summer.
New York State has a method where they actually get the
information of the State tax withheld by the end of January.
There is a quarterly report that, at the end of the year,
includes all income that that person earned and all tax that
was withheld from that person in State and local taxes.
If that information, similar information, would go to the
IRS directly--it is available. The people who prepare payroll
tax reports have to have it in order to prepare the W-2s which
have to go to the taxpayer at the end of January. The State is
able to get it, and therefore they do not have the same kind of
identity theft problems that the IRS has, because the people in
government in New York, the tax department, will tell you, we
look at that report before we issue any refund to anybody.
I think that is something that we should all be able to
agree upon: that we need to find this mechanism to have the
government, have the IRS, have the information it needs to be
able to process returns as quickly as they would like, but with
the adequate information to make a proper decision about
whether or not the refund in fact is due.
Senator Carper. All right.
Mr. Chairman, my time has run out. I have another question,
if you do not mind. It relates to the first one.
The last time I think we had an analysis of the tax gap, we
were told that the size of the tax gap--monies owed for Federal
taxes not being collected--was about $385 billion. That was in
2006. I do not know that we have updated it since that time. I
have been working on some legislation that would seek to
improve compliance, would seek to streamline administration,
and would also hopefully reduce our Federal tax gap somewhat.
Even so, targeted proposals to improve compliance will not
by themselves address this problem. There are a couple other
areas that need to be addressed, and one of those is that we
have to provide revenue authorities with sufficient funding for
effective enforcement, and the second would be that we need to
simplify the tax code, which is what this hearing is all about.
I am going to come back and ask a question kind of similar
to my last one, but different. With today's topic in mind of
tax simplification, could you all walk us through just maybe
one proposal, just one proposal, if you have not done it
already, that you believe would not only simplify the tax code
but would also simultaneously improve compliance rates and
reduce the tax gap? Mr. Fogg, do you want to lead off? Thank
you, Mr. Chairman.
Mr. Fogg. I am probably going to be repetitive.
Senator Carper. That is all right.
Mr. Fogg. If the IRS has the data before it sends out the
refunds, then I think it makes it simpler for the taxpayers.
And I think if they send out the data to the taxpayers, I think
it makes it even simpler for them to prepare their returns. And
you would not have all of the refunds going out that should
never have gone out the door, so you do not have to engage in
the compliance mechanisms of trying to collect it.
If you are trying to collect it from my clients, it is a
losing game for the IRS, because they do not have it. So, once
the money goes out the door to low-income taxpayers, unless the
IRS can offset it in some subsequent return, it is, for the
most part, lost because they do not have a way to collect it,
because the taxpayers do not have the money.
So focusing the system on getting it right at the return,
making a principle of tax administration that we are going to
get it right when people file the returns, is a way to simplify
people's lives, I think, and to avoid compliance issues because
they do not get into that compliance system.
Senator Carper. Thank you.
Mr. Bartlett, just very briefly.
Mr. Bartlett. It has been a long time since I looked at the
tax gap studies, but my recollection is that small businesses
were a particular problem, more so than individuals, and
perhaps this is simply an area where more resources need to be
expended.
Senator Carper. Good. Thank you.
Dr. Desai. Just briefly, I think on the individual side,
you would want to do what Mr. Fogg suggested, as Professor
Bankman has suggested with ReadyReturns. I think that is a
great idea. On the corporate side, I would adopt a simple true
territorial system without a minimum tax and then fund it by
looking at pass-through entities and the alignment of book and
tax income.
Senator Carper. All right. Thank you.
Ms. Markman?
Ms. Markman. Yes. I think that the IRS should be granted
the right to register and control tax preparers. I think that
what happened with the Loving case is terrible. I think that it
is very important, because that is where some of your problems
clearly come from, and that would be my one recommendation.
Senator Carper. Yes. I am Tom Carper, and I approve that
message. [Laughter.]
Senator Thune. Thank you, Senator Carper.
I want to try a couple of questions here, and then I will
hand it off to Senator Heller.
Mr. Bartlett, you indicated that it has been a long time
since anybody around here has done this. In fact, there are
only a handful of people who were here last time. I was not
here in this position as a Senator. I was here as a staffer in
the 1985-1986 time frame, and there were some things that were
strikingly different about that particular exercise than what
we are seeing as we approach this issue today.
In your testimony, you stated that strong presidential
leadership is going to be necessary to achieve any meaningful
tax reform or simplification. So this is a fairly
straightforward question, but how would you grade the current
administration in terms of their leadership on this issue,
their outreach to Capitol Hill, compared with your experience
the last time around?
Mr. Bartlett. Well, frankly, it has not been very good. It
does not appear to me that either the Treasury Secretary or the
President really have that much interest in the subject. Mr.
Lew, as you know, was Budget Director. He is a budget guy,
which is fundamentally different from being a tax guy, as I am
sure you know. You look at the world in a slightly different
sort of way.
I think it is too late in this administration to do
anything meaningful in this area, but I do not think we need to
reinvent the wheel either. One recommendation I would make is
to go back to the Bush report in, I believe, 2005. It was
actually pretty good, and I was very, very disappointed that
President Bush chose not to pursue tax reform and instead did
Social Security reform instead, so we ended up with neither.
But I do not think it would take that much work to come up with
an administration proposal if they put the massive tax staff at
the Treasury to work on this.
Senator Thune. Yes. And I do not disagree with that. I
think that the level of engagement this time around, we just
have not seen it at all relative to what happened in 1985 and
1986.
In your testimony, you stated that Congress should focus on
``a few reforms that are not controversial if there is not the
political consensus necessary for tax reform.'' So, to put that
another way, maybe, in other words, we should not let the
perfect become the enemy of the good. So what would you
consider to be the non-
controversial reforms that Congress could enact outside of a
fundamental, comprehensive reform of the tax code?
Mr. Bartlett. Oh, I think we have discussed quite a few
things here today. The point I was trying to make is
essentially the one you just made, which is, I think oftentimes
we make the perfect the enemy of the good. I think that
oftentimes there is a non-controversial tax provision that
people would be willing to enact, but it is held hostage to
say, well, we will use this as the vehicle, the engine to pull
along some of the less popular, more difficult provisions. I
just think that that has been going on for too long, and we
have a backlog of things that could be done that should be
done.
Senator Thune. Let me just ask a couple of sort of specific
questions on individual issues. One has to do with the
individual and corporate Alternative Minimum Tax, and anybody
who wants to can respond to this. But it was enacted really to
prevent a small handful of taxpayers from avoiding taxes, yet
today it ensnares literally millions of American taxpayers.
How much simplification would repeal of these taxes
provide, and are the corporate and individual AMTs still
necessary?
Ms. Markman. The individual AMT is really a stealth tax. It
requires many taxpayers to have to calculate the taxes twice.
And the provisions, all of the add-backs that are there, the
preferences that are in the law, really do not accomplish
anything, as a tax preparer, from where I sit. It is just an
unneeded complication.
If the rates were adjusted so the amount of money could be
generated from the same group of taxpayers with different
rates, I think we would greatly simplify the law. It is made
more complicated now by this new net investment income tax that
is added on top of the AMT, regardless of whether you pay the
regular tax or you pay the AMT tax. So you have tax calculation
upon tax calculation that has created a nightmare of
complexity.
Senator Thune. Does anybody else want to comment? Do we get
rid of the AMT?
Mr. Bartlett. I do not think you will find anybody who
supports it in principle.
Senator Thune. Final question. A lot of the preferences in
the tax code phase out as a taxpayer's income rises so as to
prevent these tax preferences from being claimed by higher-
income taxpayers. The Child Tax Credit, of course, is one
example of that.
How much complexity do these phase-outs add to the tax
code, and is there a better way? If the concern is maintaining
distributional neutrality, is there a better way of achieving
that objective than having the phase-outs, which end up being
pretty complicated, I think, for most people?
Ms. Markman. If the exemption amount for children was
changed, I think that would accomplish the goal about the Child
Tax Credit, at least in part. Since right now we still face,
with the Pease provisions, people losing their exemptions
anyway, it is sort of a trade-off.
If we increase it, your low-income taxpayers would get the
same or similar benefits to what they would get for the
exemption amount, and the higher-income taxpayers would lose it
as a result of those phase-outs. So you have to pick your
poison, almost. It is a different way of looking at the same
thing and has the same result.
Senator Thune. All right.
Mr. Fogg. Do you not have phase-outs that come in at all
different places depending on the particular item?
Ms. Markman. Yes.
Mr. Fogg. And I think you could create simplification by
figuring out who is a low-income taxpayer or who is a high-
income taxpayer rather than have different provisions where the
phase-out comes at different points. So, whether you want to
keep the phase-outs is a different question, but right now it
is sort of like education credits. You have so many different
ones, it is difficult for people to keep up with.
Mr. Bartlett. Well, one of the key areas of phase-outs is,
as you know, with the EITC. If you look at phase-outs that
apply to other welfare programs such as housing programs and
things of that sort, some of the most highly taxed people in
our society are very low-income people. I think that the only
reason it does not impact them more is because they are simply
not even aware of it. They find out after the fact.
Senator Thune. All right.
Dr. Desai. Just briefly, I think Pease is clearly a
nightmare, as is the EITC story. I think what you would want to
think about doing is aggregating some kind of a cap. That would
be the way to simplify, as opposed to provision-by-provision
exemptions.
Senator Thune. Like a standard deduction?
Dr. Desai. Well, but you could actually do it for higher-
income folks as well. So, some kind of aggregation.
Senator Thune. All right. Thank you.
The chairman has returned. Senator Heller is up next. Thank
you all very much.
Senator Heller. Mr. Chairman, thank you. I want to thank
the witnesses for being here today and taking time. Your
opinions are important to us, and your expertise is well noted.
I want to go back to what Senator Thune was saying, and I hate
to be duplicative, but I am going to be, Mr. Bartlett, in the
question that he asked about presidential leadership.
As you are well-aware--and correct me if I am wrong,
because I was quite young--but back in 1986, the last time we
had tax reform, obviously President Reagan was involved. His
chief of staff, Donald Regan, was involved. Treasury Secretary
Baker was involved. Do you believe we can do fundamental tax
reform without the presidential leadership? And tell me why it
is so fundamentally important that the President and his
administration be involved.
Mr. Bartlett. Well, one reason is that we have two Houses
of Congress and each one approaches things like tax reform
separately. In other words, you do not always sit here and wait
for the House to finish action before you begin action. You
operate on parallel paths.
It is extremely important for some organization like the
Treasury Department to keep an eye on everything that is going
on on both sides of the Hill and make sure that the right hand
and the left hand know what they are both doing, because it is
so easy to make mistakes and create penalties that were not
intended or subsidies that were not intended. And of course,
when you are in the hot-house atmosphere of a conference
committee, a lot of decisions get made in the blink of an eye.
It is just really important to have somebody or some
institution with the resources to keep an eye on all the
different things, all the different moving parts that are
moving simultaneously, to make sure that you end up at the end
of the day with something that improves the tax system.
Senator Heller. Right. So I guess I ask the question, can
we do it without the administration?
Mr. Bartlett. Personally, I do not think so. I am not aware
of any major tax reform in history that did not originate with
or have deep administration involvement. The 1969 Act was
essentially drafted by the Treasury Department.
I am not sure precisely who drafted the 1976 Act, but of
course the 1986 Act came out of a massive Treasury study.
Although a lot of it was abandoned, a lot of it stayed, and so
I just think the history shows that, if you are talking about
tax reform as opposed to a tax cut, it is just absolutely
essential.
Senator Heller. Great. Mr. Bartlett, thank you.
Dr. Desai, in one of your comments, you mentioned that
lawmakers could get revenue through pass-through entities. As
we are looking at overhaul of the tax code, could you explain
how we might be able to do that?
Dr. Desai. Well, just so we understand the magnitude of the
numbers, if you think about how much business income is being
taxed through the corporate tax, about two-thirds of it is not
being taxed through the corporate tax. So now more than ever
before, we have business income in non-corporate form, and that
is pass-through entities. It is also real estate investment
trusts, it is MLPs. There is a proliferation of entities out
there.
What is basically happening is corporations have figured
out that there is a ready way to take a bunch of income. They
hive themselves into what are called prop cos and op cos--
property companies and operating companies--and they put all
that property income into a pass-through entity. That is highly
problematic. So to address it, one would want to think about
having some kind of a minimum tax on income that is generated
through pass-through entities, and even a small tax there would
actually raise a remarkable amount of revenue.
I will just mention there, the revenue raiser is that we
have a situation where corporations routinely report large
profits to capital markets and do not report those same profits
to tax authorities, and that is a conundrum. It could be fixed
if there was a better alignment on defining income for tax
authorities and capital markets.
Senator Heller. Dr. Desai, thank you.
This is probably a question, if time allows, for us to go
down the row. We have had a number of proposals come before us.
Some examples, of course, are the Simpson-Bowles Commission;
the previous Senate Finance Committee chairman, Max Baucus, had
some ideas on how to address the complexity in the tax code;
and of course, our prior Ways and Means Committee chairman,
Dave Camp.
So we have had numerous ideas that have come in front of
this Congress. I think this is as bipartisan an issue as
possible, and that is the simplification of our tax code. I
think we can get agreement on both sides of the aisle.
What are your views on these various proposals?
Ms. Markman. I am really not sufficiently versed to be able
to address them one at a time. But I think that if they were
studied and they were looked at, and we said, okay, we are
going to pick the best ideas or the best three ideas from each
of them, you probably would come up with something very good,
because each of them is well thought-out, and they were
comprehensive. But specifically, I am sorry, I cannot address
that.
Senator Heller. Thank you.
Doctor?
Dr. Desai. I would just briefly say that the best
compendium of good ideas that we have in the recent past is the
President's Advisory Panel on Federal Tax Reform that was done
in 2005. That was----
Senator Heller. The Simpson-Bowles?
Dr. Desai. No, this was a committee that was put together
and was roughly abandoned, but that 2005 report is a great
place to look.
Senator Heller. Thank you.
Mr. Bartlett. If memory serves, the Joint Committee was
required to produce a three-volume study on complexity and
simplification not that many years ago. I do not think the law
has changed that much since then. Perhaps the Joint Committee
could boil some of that down into something that could be
legislated.
Senator Heller. Mr. Fogg?
Mr. Fogg. I am going to just address it from the
perspective of low-income taxpayers. So the more you get them
out of the system, the happier they will be. When you use the
tax system to deliver benefits, you are dragging them back in,
and that is creating problems for them. So that is a form of
benefit-giving that is creating a lot of complexity for their
lives.
Senator Heller. Thank you very much. Mr. Chairman, thank
you, and thanks for your commitment to this issue.
The Chairman. Well, thank you, Senator Heller.
Let me just ask one other question of you, Dr. Desai. You
commented in your testimony about the ``planning complexity''
dynamic in the international tax arena. First, would you
provide us some context around this dynamic? Second, would you
agree that moving our international tax rules in the direction
of the President's proposal, the 19-percent minimum tax, would
do more harm by enhancing rather than alleviating the planning
complexity dynamic, and that a move to a territorial-type
system of tax administration is a better path forward?
Dr. Desai. Well, so the dynamic I was alluding to, I think,
is most evident in the international arena, but I think it is
broad, and that is a dynamic where there is a concern about
planning and there are rules and laws passed to address it.
That creates complexity which planners can then plan around.
That creates another effort to address it, and so on and so
forth, and the international system is rife with that. There
are various examples of it.
Right now I think the minimum tax is such an example, which
is, it is an effort within what is broadly a territorial system
to basically repeal deferral. The consequence of that is going
to be a remarkable amount of effort to engineer around those
rules by people who have enormous resources. So my instinct is
that it is going to, (A) cause more harm than good, and (B), if
you have that policy goal, which I disagree with, you would be
better to repeal deferral. That would be a simple way to
achieve that.
One of the things that is important here is to achieve
things in the simplest way. Things like Pease that are stealth
taxes, or things like a minimum tax in a territorial system
that is a self-tax, or the AMT, they are highly problematic,
and this is just one example of them. So, yes, I think
obviously the right way to go is a much simpler system, which
would be a true territorial system.
The Chairman. Well, thank you. This has been a particularly
interesting panel to me. I am sorry I had to go to the anti-
trust hearing over at Judiciary. I apologize that I missed part
of your testimony. But what I heard was very, very helpful to
this committee. I just want to thank each of you for appearing
today and taking the time to be with us.
We are going to see what we can do to simplify this tax
system that we have. It is going to take an awful lot of effort
and an awful lot of help from not just people here, but people
outside as well. We hope you will help us, and continue to help
us understand how to do this and what we should do a little bit
better than maybe has been the case in the past.
So I want to thank each of you for taking the time out of
your busy schedules to be with us, and, with that, we will
recess until further notice.
[Whereupon, at 11:48 a.m., the hearing was concluded.]
A P P E N D I X
Additional Material Submitted for the Record
----------
Prepared Statement of Bruce Bartlett, Former Deputy Assistant Secretary
for Economic Policy (1988-1993), Department of the Treasury
Thank you for the opportunity to testify today on the subject of
tax complexity, compliance, administration and simplification. I speak
not as a tax practitioner, but as someone who has observed the tax
policy process at close hand for several decades and written frequently
on the subject. I will confine my comments to general observations
about what has given rise to tax complexity, what ``simplification''
means in practice, and obstacles to the achievement of meaningful
simplification.
1. Distribution tables drive a lot of complexity. Although it is
seldom said out loud, an important underlying assumption in all major
tax bills is rough distributional neutrality or mild progressivity.
This means that tax writers are vitally dependent on the distribution
tables produced by the Joint Committee on Taxation. There are many
technical and conceptual problems with these tables that I won't go
into.\1\ One longstanding problem is that no one is quite sure who
exactly pays the corporate income tax.\2\ I will simply note that if a
table looks ``wrong'' by giving too much of a tax cut to those at the
top, this requires redress through some mechanism to take back part of
the cut to those in some specific income group as the JCT defines
``income.'' \3\ Often these fixes are complicated and convoluted; I'm
thinking about PEP and Pease, for example.\4\
---------------------------------------------------------------------------
\1\ Michael J. Graetz, ``Paint-By-Numbers Tax Lawmaking,'' Columbia
Law Review (April 1995).
\2\ Some recent contributions to the debate on this topic include,
``Modeling the Distribution of Taxes on Business Income,'' Joint
Committee on Taxation (Oct. 16, 2013); Julie-Ann Cronin et al.,
``Distributing the Corporate Income Tax: Revised U.S. Treasury
Methodology,'' National Tax Journal (March 2013); ``How TPC Distributes
the Corporate Income Tax,'' Tax Policy Center (Sept. 13, 2012);
Kimberly A. Clausing, ``Who Pays the Corporate Tax in a Global
Economy?'' National Tax Journal (March 2013).
\3\ Edward D. Kleinbard, ``Reading JCT Staff Distribution Tables:
An Introduction to Methodologies and Issues,'' Joint Committee on
Taxation (Dec. 9, 2008).
\4\ ``Deficit Reduction: The Economic and Tax Revenue Effects of
the Personal Exemption Phaseout (PEP) and the Limitation on Itemized
Deductions (Pease),'' Congressional Research Service (Feb. 1, 2013).
2. It's very hard to cut income taxes without disproportionately
benefitting the rich. That is because they pay most of the taxes. Any
simple cut in rates, even if it is across the board, will produce
distribution tables showing massive tax cuts for those at the top, very
modest cuts for those in the middle, and nothing at all for those at
the bottom because they have no income tax liability. The only way you
can ``cut taxes'' for those with no liability is by making a tax credit
refundable. But this simply redefines direct spending into a tax
benefit, which is somewhat Orwellian, but satisfies the need to get a
---------------------------------------------------------------------------
distribution table that looks ``right.''
3. Just because some person or business has no income tax liability
doesn't mean they are relieved of tax complexity. When the Tax Reform
Act of 1986 was enacted, President Reagan praised it for tax
simplification based largely on the fact that a number of taxpayers had
been taken off the tax rolls.\5\ In effect, he was asserting that
paying no income taxes was per se simplification. Of course, this was
nonsense. The EITC is the primary reason many people with positive
income have no tax liability and often receive a ``refund'' even though
they paid no taxes to be refunded. But the EITC involves complex
calculations. Similarly, many small businesses with little or no tax
liability may still have complicated returns. And there are big
corporations that often have no tax liability that work very hard and
jump through a lot of complicated tax hoops to achieve that result. My
point is simply that just because someone has no tax liability doesn't
mean they automatically have simple taxes, and just because some
legislation increases the number of non-taxpayers doesn't mean that
Congress has made the Tax Code simpler.
---------------------------------------------------------------------------
\5\ Ronald Reagan, ``Remarks on Signing the Tax Reform Act of
1986,'' The White House (Oct. 22, 1986).
4. Some of the most serious issues in tax complexity are
fundamental to the very nature of an income tax. The problem is that it
is becoming harder and harder to say precisely what ``income'' is, or
at least taxable income, in today's world. As this committee knows, the
term ``income'' is nowhere defined in law.\6\ Once upon a time when the
only income most people received was wages, pensions and perhaps a bit
of interest, this was not a problem. But more and more workers these
days, such as Uber drivers, are independent contractors; in effect,
small businesses, with expenses and incomes that may take multiple
forms. The wealthy, especially if they are business owners, can often
easily convert wage or interest income into lower-taxed capital gains
or dividends. And of course big corporations have whole departments
devoted to avoiding the realization of taxable income. Most of the Tax
Code's complexity comes from reporting income.\7\
---------------------------------------------------------------------------
\6\ Alice C. Abreu and Richard K. Greenstein, ``Defining Income,''
Florida Tax Review (2011); Erik M. Jensen, ``The Taxing Power, the
Sixteenth Amendment, and the Meaning of `Incomes,' '' Arizona State Law
Journal (Winter 2001); Martin D. Ginsburg, ``Taxing the Components of
Income: A U.S. Perspective,'' Georgetown Law Journal (Oct. 1997).
\7\ Rosemary Marcuss et al., ``Income Taxes and Compliance Costs:
How Are They Related?'' National Tax Journal (Dec. 2013).
5. Adopting a consumption tax has the potential to achieve
meaningful simplification. One reason is that consumption is more
easily defined and taxed, especially in an increasingly globalized
economy, than income.\8\ Thus we would be shifting the tax base from
something that is increasing intangible to something that is more
concrete.\9\ Another benefit is that the burden of tax collection would
be shifted from individuals to businesses that are better able to
employ tax experts. Of course, even consumption taxes break down and
Europe has a growing problem with VAT evasion.\10\ But at least in
principle, individuals would benefit in terms of simplification by
paying their taxes as they buy things, rather than having to keep track
of income and all the exemptions, exclusions, deductions and credits
that go with our income tax system.\11\ I am highly sympathetic to the
tax plan devised by Columbia University law professor Michael Graetz,
which would go a long way toward achieving meaningful simplification
for most people by eliminating their need to keep records or even file
returns.\12\
---------------------------------------------------------------------------
\8\ James R. Hines Jr. and Lawrence H. Summers, ``How Globalization
Affects Tax Design,'' Tax Policy and the Economy (July 2009).
\9\ Edward J. McCaffery, ``A New Understanding of Tax,'' Michigan
Law Review (March 2005).
\10\ ``2012 Update Report to the Study to Quantify and Analyse the
VAT Gap in the EU-27 Member States,'' European Commission (Sept. 2014);
Michael Keen and Stephen Smith, ``VAT Fraud and Evasion: What Do We
Know and What Can Be Done?'' National Tax Journal (Dec. 2006).
\11\ Bruce Bartlett, ``The Conservative Case for a VAT,'' Tax
Analysts (Feb. 11, 2011).
\12\ Michael Graetz, ``The Tax Reform Road Not Taken--Yet,''
National Tax Journal (June 2014).
6. We could do a lot more to achieve no-return filing for many
people even within the current tax system. Few people realize that even
under current law, the IRS will calculate your taxes for you if you
have a limited income sources, don't itemize or use special tax forms,
and have an income below $100,000.\13\ Any number of studies by the
Treasury Department and others have shown how return-free filing could
be expanded.\14\ Other countries have such a system.\15\ One problem is
that return-free filing would probably require increased withholding on
things like dividends and interest. I don't need to remind this
committee how unpopular that would be.\16\
---------------------------------------------------------------------------
\13\ IRS, Tax Guide for Individuals, 2014, p. 205.
\14\ U.S. Treasury Department, Report to the Congress on Return-
Free Tax Systems: Tax Simplification Is a Prerequisite (Dec. 2003);
Austan Goolsbee, ``The Simple Return: Reducing America's Tax Burden
Through Return-Free Filing,'' Brookings Institution (July 2006).
\15\ William G. Gale and Janet Holtzblatt, ``On the Possibility of
a No-Return Tax System,'' National Tax Journal (Sept. 1997); Koenraad
Van der Heeden, ``The Pay-As-You-Earn Tax on Wages: Options for
Developing Countries and Countries in Transition,'' International
Monetary Fund (Sept. 1994). Just the other day, I noticed that
Singapore's Inland Revenue Authority was praising the benefits of its
no-filing service.
\16\ Withholding on interest was instituted by the TEFRA
legislation in 1982. It was so unpopular it was repealed six months
after taking effect. ``Congress Passes Repeal of Interest
Withholding,'' New York Times (July 29, 1983).
7. Contrary to popular belief, a single statutory rate tax does
very little to simplify the tax system. In 1978, there were 26
statutory income tax brackets; 10 years later there were only two. It
was widely believed that this led to meaningful simplification for
individuals. In fact, the simplification was superficial; the vast bulk
of complication in the tax system comes from defining the tax base. The
great advance in simplification promised by the original flat tax
proposal developed by Stanford scholars Robert Hall and Alvin Rabushka
came from adopting a pure consumption tax base; the single rate was
basically the cherry on top.\17\ In any case, it is effective marginal
rates that matter, economically, and just about any effective rate can
be achieved even under a flat rate system depending on the nature of
the tax base. Furthermore, surveys have shown that hardly anyone knows
what their tax bracket is and tend to grossly overestimate it. Keep in
mind also that the corporate tax has always been essentially a flat
rate, but no one thinks the corporate tax system is simple. There is no
evidence that fewer tax brackets improves economic efficiency.\18\
---------------------------------------------------------------------------
\17\ Charles E. McLure Jr., ``The Simplicity of the Flat Tax: Is It
Unique?'' American Journal of Tax Policy (Fall 1997); Lawrence Zelenak,
``The Selling of the Flat Tax: The Dubious Link Between Rate and
Base,'' Chapman Law Review (Spring 1999); Alan L. Feld, ``Living With
the Flat Tax,'' National Tax Journal (Dec. 1995).
\18\ David Altig and Charles T. Carlstrom, ``The Efficiency and
Welfare Effects of Tax Reform: Are Fewer Tax Brackets Better Than
More?'' Federal Reserve Bank of Cleveland (1994).
Table 1--Tax Rate Perceptions and Reality, 2010
----------------------------------------------------------------------------------------------------------------
On average, about what percentage of their household incomes would you guess most Americans pay in federal
income taxes each year--less than 10 percent, between 10 and 20 percent, between 20 and 30 percent, between 30
and 40 percent, between 40 percent and 50 percent, or more than 50 percent, or don't you know enough to say?
-----------------------------------------------------------------------------------------------------------------
Tea Party
Tax/Income All Members Actual
----------------------------------------------------------------------------------------------------------------
Less than 10%................................................ 5% 11% 86.5%
10%-20%...................................................... 26% 25% 12.9%
20%-30%...................................................... 25% 26% 0.6%
30%-40%...................................................... 10% 14% 0.6%
40%-50%...................................................... 2% 3% 0.6%
More than 50%................................................ 1% 1% 0.6%
Don't know................................................... 31% 15% n/a
----------------------------------------------------------------------------------------------------------------
Sources: New York Times/CBS News Poll, Joint Committee on Taxation.
8. Even radical simplification and reform is highly unlikely to
raise economic growth more than a small amount and only over a long
period of time.\19\ I know that there are estimates of the compliance
cost and the deadweight cost of the tax system that are very high.\20\
But the compliance cost is like the cost of commuting to and from work;
reducing it would improve our well-being, but wouldn't necessarily
raise growth and might even reduce it based on the way GDP is
calculated. Reducing the deadweight cost would have an effect similar
to reducing the effective marginal tax rate. But as we know from
experience after the 1986 reform, which lowered the top rate from 50
percent to 28 percent, there was no outpouring of growth. Serious
efforts by economists to find any economic impact from the 1986 Act
have turned up very little; mostly accounting changes, not real
economic effects.\21\ The effect of statutory tax rates on growth tend
to be grossly exaggerated.\22\
---------------------------------------------------------------------------
\19\ Nancy L. Stokey and Sergio Rebelo, ``Growth Effects of Flat-
Rate Taxes,'' Journal of Political Economy (June 1995); William G. Gale
and Andrew A. Samwick, ``Effects of Income Tax Changes on Economic
Growth,'' Brookings Institution (Sept 9, 2014); ``Economic Growth and
Tax Policy,'' Joint Committee on Taxation (Feb. 20, 2015).
\20\ Martin Feldstein, ``Tax Avoidance and the Deadweight Loss of
the Income Tax,'' Review of Economics and Statistics (Nov. 1999);
``Summary Estimates of the Costs of the Federal Tax System,'' U.S.
Government Accountability Office (Sept. 27, 2005).
\21\ Alan J. Auerbach and Joel Slemrod, ``The Economic Effects of
the Tax Reform Act of 1986,'' Journal of Economic Literature (June
1997); David A. Guenther, ``Earnings Management in Response to
Corporate Tax Rate Changes: Evidence from the 1986 Tax Reform Act,''
Accounting Review (Jan. 1994); Anil Kumar, ``Labor Supply, Deadweight
Loss and Tax Reform Act of 1986: A Nonparametric Evaluation Using Panel
Data,'' Journal of Public Economics (Feb. 2008).
\22\ ``Tax Rates and Economic Growth,'' Congressional Research
Service (Jan. 2, 2014); ``Taxes and the Economy: An Economic Analysis
of the Top Rates Since 1945,'' Congressional Research Service (Dec. 12,
2012).
9. Strong presidential leadership will be necessary to achieve any
meaningful tax reform or simplification. Political studies of the 1986
act show that President Reagan's personal commitment and the active
engagement of the Treasury Department were essential to its
enactment.\23\ One problem, as this committee well knows, is that of
what is sometimes called ``salami-slicing,'' small compromises to a
proposal that was carefully balanced can eventually add up to something
worse than nothing at all. I am disappointed that President Bush chose
to ignore the recommendations of his tax reform panel, which were very
good, and that President Obama and the Treasury have shied away from
active engagement in this issue other than to offer a relatively
limited business-only reform proposal.\24\ The expiration of the Bush
tax cuts would have been a perfect opportunity to develop a larger tax
package that would have improved the tax code, but it was not utilized.
---------------------------------------------------------------------------
\23\ Robert P. Inman, ``Presidential Leadership and the Reform of
Fiscal Policy: Learning from Reagan's Role in TRA 86,'' NBER Working
Paper No. 4395 (July 1993); John F. Witte, ``The Tax Reform Act of
1986: A New Era in Tax Politics?'' American Politics Research (Oct.
1991).
\24\ President's Advisory Panel on Federal Tax Reform, Report
(April 13, 2005); ``The Advisory Panel's Tax Reform Proposals,''
Congressional Research Service (July 13, 2006); ``The President's
Framework for Business Tax Reform,'' White House and Treasury
Department (Feb. 2012).
10. Tax policy should pay more attention to horizontal equity. It
is a generally accepted principle of taxation that those with similar
incomes should pay similar taxes. The complexity of our current system,
however, causes tax rates to vary tremendously between those with
roughly the same income. The following table and figure illustrate this
point.
---------------------------------------------------------------------------
\25\ Council of Economic Advisers, Economic Report of the
President, 2012, p. 88.
Table 2--Distribution of Average Federal Tax Rates, 2012
----------------------------------------------------------------------------------------------------------------
Average rate at each breakpoint in the rate
distribution
Family cash income group -------------------------------------------------
10th 25th Median 75th 90th
----------------------------------------------------------------------------------------------------------------
Lowest quintile............................................... -13.7 0.0 5.4 13.1 15.5
Second quintile............................................... -8.7 0.5 7.2 17.0 20.9
Middle quintile............................................... 1.7 5.4 13.3 20.4 23.5
Fourth quintile............................................... 7.2 12.1 17.2 22.3 26.2
Highest quintile.............................................. 12.1 17.4 21.9 26.0 29.3
Top 1 percent................................................. 8.7 21.2 29.6 32.3 34.6
-------------------------------------------------
Total..................................................... 0.0 5.0 14.5 20.7 25.0
----------------------------------------------------------------------------------------------------------------
Source: Treasury Department; includes income, corporate and payroll taxes. \25\
[GRAPHIC] [TIFF OMITTED] T31015.001
11. Please make all the ``extenders'' permanent or get rid of them.
This is particularly a problem with the R&D credit, which has been
extended 16 times, often retroactively.\26\ By never having been
enacted permanently, it fails to achieve its purpose of stimulating
additional R&D and is instead a reward for what companies would have
done anyway.\27\
---------------------------------------------------------------------------
\26\ Michael Brossmer et al., ``Sweet 16: The Research Tax Credit
Gets Its 16th Extension,'' Tax Notes (March 2, 2015).
\27\ McGee Grigsby and John Westmoreland, ``The Research Tax
Credit: A Temporary and Incremental Dinosaur,'' Tax Notes (Dec. 17,
2001).
12. Combine overlapping tax incentives for the same purpose. There
are many tax subsidies for education, retirement saving and other
worthwhile purposes.\28\ Consolidating these incentives would not only
achieve simplification, but provide an opportunity to better target
them toward those that need them.
---------------------------------------------------------------------------
\28\ Elaine Maag, ``Tax Simplification: Clarifying Work, Child, and
Education Incentives,'' Tax Notes (March 28, 2011).
13. Please give the IRS more money. It has been forced to cut back
on taxpayer assistance because of cuts to its budget.\29\ It has also
cut back on audits, thus making the tax system more unfair by rewarding
tax evaders.
---------------------------------------------------------------------------
\29\ Liz Weston, ``Prepare to Wait for U.S. Tax Help,'' Reuters
(March 2, 2013); ``Observations on IRS's Operations, Planning, and
Resources,'' U.S. Government Accountability Office (Feb. 27, 2015).
14. Give up on fundamental tax reform for now and concentrate on a
few reforms that are not controversial and will help improve and
simplify the Tax Code. The dream of a tear-up-the-tax-code-and-start-
over-from-scratch reform is very appealing, but it has never been done
in our history. Even a reform as big as those in 1969, 1976 and 1986
appears beyond reach in the present political environment. The hope of
doing a big once-and-for-all reform, unfortunately, has held hostage
legislation that is needed and would incrementally improve the code. I
think some members of Congress believe that noncontroversial reforms
need to be saved for fundamental tax reform, perhaps as sweeteners. An
alternative view would be that if Congress can just do any kind of
meaningful reform on a bipartisan basis, which is essential, then maybe
it would improve the prospects for everyone working together on
---------------------------------------------------------------------------
something bigger.
15. It does nothing to restrain the growth of taxation to make
paying our taxes as difficult as possible. There is a school of thought
that says the more painful taxes are the more people will hate them,
which will encourage support for tax cuts and opposition to tax
increases.\30\ This has always been the principal reason why many
conservatives oppose the VAT--they fear that is too good a tax and thus
will lead to a higher tax burden than would be the case if tax
collection and payment is extremely burdensome. But it should be
remembered that the deadweight cost of taxation--the lost production
over and above the tax--is an implicit tax. So by maintaining and
excessively burdensome tax system to keep the explicit tax take as low
as possible, we are simply imposing higher de facto tax rates in
another form.
---------------------------------------------------------------------------
\30\ Gary S. Becker and Casey B. Mulligan, ``Deadweight Costs and
the Size of Government,'' Journal of Law and Economics (Oct. 2003).
______
Prepared Statement of Mihir A. Desai, Ph.D., Mizuho Financial Group
Professor of Finance and Professor of Law, Harvard University
Chairman Hatch, Ranking Member Wyden, and Members of the Committee,
it is a pleasure to appear before you today to discuss tax complexity
and the importance of simplification. I am a Professor of Finance at
Harvard Business School, a Professor of Law at Harvard Law School and a
Research Associate of the National Bureau of Economic Research.
Complexity in the tax code has negative redistributive and growth
consequences that have only accelerated over time as more and more
policy goals are now implemented through the tax system. My comments
attempt to outline briefly the harmful effects of complexity,
particularly egregious examples of complexity, and a proposal for
remedying complexity in the tax code.
1. Our complex economy must be matched with thoughtful and detailed
tax rules. As such, railing against all complexity is naive.
Instead, the types of complexity that deserve our attention are
either (i) when taxpayers have difficulty in complying with the
law, (ii) when the IRS cannot enforce the laws, or (iii) when
complexity gives rise to planning opportunities.
Compliance complexity is most prevalent with individual taxpayers
and small businesses. The web of education incentives in the
tax code provides a paradigmatic example of such complexity.
Compliance complexity retards efforts of policymakers by
reducing uptake, increases the likelihood that the behavior
rewarded with tax expenditures is inframarginal (leading to
windfalls to taxpayers rather than to the desired changes in
behavior), and redistributes wealth toward sophisticated
taxpayers and tax advisers who can manage this complexity.
Administrative complexity is most common with business taxes and is
manifest, for example, when the IRS relies on the actions of
auditors, as independent verification is often beyond the
abilities or resources of the IRS. This type of complexity
again rewards sophisticated taxpayers and investment in non-
productive activity but also creates a crisis of confidence in
the tax code when taxes effectively become optional for
sophisticated taxpayers. [See Reference 4]
2. The final type of complexity arises from a ``call and response''
pattern of tax planning by practitioners that provokes more
detailed, bright-line rules by administrators that, in turn,
triggers new tax planning opportunities and so on. This death
spiral of planning-regulation complexity is evidenced in the
most important area of business taxes--international tax
rules--where complex rules govern an unwieldy system that
raises little revenue. As a recent example of this dynamic,
last year's Treasury notice designed to prevent inversion
transactions will have the primary effect of transferring
wealth to foreign multinational firms and those firms that
inverted prior to the proposed regulations as they have become
advantaged acquirers of U.S. assets. Indeed, several years of
anti-inversion legislation and rules have only served to
increase the planning activities around mergers and the real
distortions undertaken to achieve tax savings.
3. Recent proposals to enact an alternative minimum tax on foreign
source income within a proposed territorial regime provide the
latest example of the vices of this planning-complexity
dynamic. Such proposals attempt to prevent planning by
implementing a de facto worldwide system of taxation without
deferral at, for example a nineteen percent rate, on a per
country basis but label it a territorial regime. It would be
preferred to explicitly repeal deferral within a worldwide
regime rather than to enact such a ``backdoor'' worldwide
regime--much as today's worldwide system that functions as
territorial is much worse than a true territorial regime. Such
complexity creates numerous opportunities for planners that
have resources that far eclipse the ability of the government
to police them--and their efforts will trigger a new round of
regulations with further distortions and more planning
opportunities. A simple territorial system as implemented by
governments around the world, with anti-abuse provisions and a
simple adjustment to address expense allocation, provides the
best alternative to ensure that the corporate tax systems
advances, rather than retards, the interests of American
workers and firms. [See References 5, 6 and 7]
4. Addressing complexity in the tax code requires analogizing to other
complex systems and drawing on the research that demonstrates
how to manage that complexity. In short, the complexity of the
tax code could be managed much as the complexity of software
code is managed. This analogy yields two primary lessons.
First, ``over the wall'' engineering is highly problematic and
``concurrent'' engineering is preferred. Throwing completed
ideas ``over the wall'' to the next part of the production
process limits learning and engenders complexity relative to a
concurrent and iterative production process. Currently, policy
ideas are often developed without a clear vision of the
associated language and with even less attention to the
perspective of administrators. The practice of policy
formulation and drafting must be a collaborative activity with
the administrative agency in charge of enforcement. More
consistently following and strengthening the recommendations in
Sections 4021 and 4022 of The Internal Revenue Service
Restructuring and Reform Act of 1998 would provide for a
considerable bulwark against creeping complexity by preventing
``over the wall'' engineering.
5. Second, and more radically, we could embark on an effort to open up
the administrative and legislative process in order to
effectively ``crowdsource the code.'' Effective management of
complex codes--be it Linux or the tax code--requires three
steps. First, a code must be mapped so that the
interrelationships, technically and conceptually, of the
different parts of the code become manifest. Second, this
mapping enables modularization whereby the code is reorganized
into pieces that reflect these relationships. Finally, this
modularization provides the foundation for opening up the code
to experts throughout society who contribute suggestions for
rationalization and simplification. [See References 2, 8, 9,
10, and 11]
6. Currently, the code, to the degree its complexity is managed at
all, is managed much as it was fifty years ago--in a
fundamentally closed manner. Laws and administrative guidance
are drafted by small groups in a non-transparent way that pays
little attention to the overall architecture of the tax system.
As a consequence, vested interests influence the management of
complexity toward their advantage and complexity grows by
ignoring interrelationships.
7. By mapping, modularizing and opening the code and associated
guidance we could draw upon widespread expertise, provide
transparency on a critical process, address the imbalance in
resources between the taxing authority and sophisticated
taxpayers and begin the process of simplifying the code and the
associated administrative guidance. A modest manifestation of
the power of crowdsourcing ideas on the code is provided in
Appendix A, which compiles the suggestions of twenty experts on
complexity. In the limit, one could imagine a detailed mapping
of the tax code and associated regulations much as software
code is mapped. This mapping would then serve as a guide to
reorganizing laws and regulations over time. While decision
making rights would remain where they currently reside,
opinions on policies would then be solicited widely and the
drafting of laws and regulations could be aided by experts
around the country through an open platform.
8. Finally, three structural features of our tax system most
contribute to complexity. First, consumption taxes have major
simplification advantages over income taxes as the base is more
readily identified, particularly given the growing importance
of cross-border flows and intellectual property. Second, the
reliance on realization events engenders great complexity that
could be alleviated by considering accrual taxation in some
settings. Third, the reluctance to embrace solutions that
provide taxpayers with the information that tax authorities
already have, as with ReadyReturns, is a major cause of
unnecessary complexity in the individual arena. Structural
reforms that address these sources of complexity would allow
for considerable simplification. [See References 1, 3, 4 and
12]
I look forward to your efforts in this important area and I'd be
delighted to answer any questions.
References:
1. Andrews, William. ``The Achilles' Heel of the Comprehensive Income
Tax,'' in New Directions in Federal Tax Policy for the 1980s, 1983,
Charles Walker and Mark Bloomfield (eds.) 278-286.
2. Baldwin, Carliss, Alan MacCormack and John Rusnak. ``Hidden
structure: Using network methods to map system architecture.'' Research
Policy 43 (2014): 1381-1397.
3. Bankman, Joseph. ``Using Technology to Simplify Individual Tax
Filing,'' National Tax Journal, December 2008, 61: 773-789.
4. Bradford, David F. Untangling the Income Tax, Harvard University
Press, 1986.
5. Desai, Mihir. ``A Better Way to Tax U.S. Businesses.'' Harvard
Business Review 90, nos. 7-8, July-August 2012: 135-139.
6. Desai, Mihir, and Dhammika Dharmapala. ``Do Strong Fences Make
Strong Neighbors?'' National Tax Journal 63 (December 2010): 723-740.
7. Desai, Mihir A., and James R. Hines Jr. ``Evaluating International
Tax Reform.'' National Tax Journal 56, no. 3 (September 2003): 409-440.
8. Langlois, Richard N. and Giampaolo Garzarelli. ``Of Hackers and
Hairdressers: Modularity and the Organizational Economics of Open-
source Collaboration.'' Industry and Innovation 15, no. 2 (2008): 125-
143.
9. Lerner, Josh, Parag Pathak and Jean Tirole. ``The Dynamics of Open
Source Contributors'' American Economic Review, Vol. 96, No. 2, pp.
114-118, 2006.
10. MacCormack, Alan, John Rusnak and Carliss Baldwin. ``Exploring the
Structure of Complex Software Designs: An Empirical Study of Open
Source and Proprietary Code.'' Management Science 52, no. 7 (July
2006): 1015-1030.
11. Sharman, David M. and Ali A Yassine. ``Characterizing complex
product architectures.'' Systems Engineering 7, no. 1 (2004): 35-60.
12. Viard, Alan D. ``Moving Away from the Realization Principle,'' Tax
Notes, November 17, 2014, 847-853.
Appendix A
Identifying Excessive Complexity in the Code
This appendix provides an anonymized catalog of responses from
twenty-one tax experts when asked about areas of excessive complexity
#1
An obvious candidate for excessive complexity are the ``anti-NOL-
trafficking'' rules of section 382 and the regulations thereunder,
especially the aspects of the rules that require a corporation to
identify and track 5+% shareholders or ``public groups'' of
shareholders to determine whether there has been an ``ownership
change'' with respect to the corporation, in which case its ability to
use its pre-existing NOLs and other tax attributes to shelter future
taxable income is limited. The IRS has in the last few years issued
some regulations that ease the burden of applying these rules, but they
are still inordinately complex in their application.
_______________________________________________________________________
#2
Section Code 704(b):
(b) A partner's distributive share of income, gain, loss,
deduction, or credit (or item thereof) shall be determined in
accordance with the partner's interest in the partnership (determined
by taking into account all facts and circumstances), if--
(1) the partnership agreement does not provide as to the partner's
distributive share of income, gain, loss, deduction, or credit (or item
thereof), or
(2) the allocation to a partner under the agreement of income,
gain, loss, deduction, or credit (or item thereof) does not have
substantial economic effect.
In English, this means that allocations of income are dictated by
the partnership agreement. If, however, the such an allocation does not
have ``substantial economic effect,'' then the correct allocation for
tax purposes will be determined by the ``partner's interest in the
partnership'' (i.e., the real economics of the deal.)
The real complexity is in the 704(b) regs. Take a look. They are
astounding. The regs provide various safe harbors. So complex, in fact,
that they are mostly disregarded in private equity funds, as many funds
opt not to try to comply with the rules, and instead rely on the
baseline rule in the statute that if an allocation does NOT have
substantial economic effect, then the correct allocation will be
determined by the ``partner's interest in the partnership.''
There are a couple of simplification options. One option is to
abolish non-economic or ``special'' allocations.
Another is to eliminate subchapter K and instead tax all
partnerships through the subchapter S rules (with some minor
modifications). I think Dave Camp proposed this as an option. Perhaps
the easiest, politically, is simply to revise 704(b) to make the
baseline rule of ``partner's interest in the partnership,'' i.e., tax
follows economics. There will obviously be some cases where it is
unclear whether a tax allocation does in fact follow economics. But
most partnerships are concerned with business goals, not tax avoidance,
and it's not like current law makes it easy to police tax avoidance. So
let's make it easy for the vast majority of partnerships that just want
to accomplish business goals.
_______________________________________________________________________
#3
A. Examples that affect reasonably ordinary events or a large number
of people--the capital gain rules for individuals' business
property and the earned income tax credit.
1. I buy a computer in 2014 and sell it in 2015. For basis I go to
1011, 1012, 1016 (subtracting applicable 179 expensing (if
elected) and 167/168 depreciation). Amount realized should be
simple assuming I do not take back a note. I go to 1223 for my
holding period. If the computer is used (in whole or in part)
in my business, 1245 depreciation recapture will apply, and
gain in excess of depreciation goes through 1221(2) to the 1231
hotchpot. If some gain is capital, it goes through 1222
waterfall. I have to apply 1(h) rate rules. It is worse if it
is real property used in my business because of 1250 and 1(h).
This could be a lot simpler without having to shift to a
consumption tax (where other problems arise).
Quick fixes (without much thought): As in 1986, repeal preferential
capital gain rate (especially if overall rates go close to 30%) and
allow all capital losses (short-and long-term) to net; repeal 1231
under any circumstance; if preferential capital gain is retained make
it a percentage deduction.
Counter argument: This is mostly calculation complexity and can be
done on TurboTax, which most business people can use.
2. EITC: I would just send you to the pages in the 1040 instructions
for the EITC to prove this point. Nina Olson's National
Taxpayer Ombudsman Report of a few years ago highlighted EITC
among a series of complexity issues and it is annually on the
list of highest erroneous government payments.
Quick fix: Make the credit/refund a percentage of payroll/self-
employment tax paid keyed to filing status and family size--Nina's
report may have had a better idea.
Counter argument: There really is not a good one if we insist on
using the tax system to transfer payments.
Taxing a child's investment income at parent rates is incredibly
complex but affects fewer people and rich kids (or kids of rich
parents) tend to be less sympathetic.
B. My second response is that every formal taxpayer election (not to
mention de facto elections) increases complexity because it
calls for running the numbers both ways (not that everyone
does). I question the need for 95%-99% of the formal elections
in the Code. If it is necessary to use an election, the rule is
a bad one or a political itch is being scratched. But each one
must be coded, monitored by the IRS and thought about by
taxpayers and advisers. There are hundreds.
Two of many possible sources for ideas are: New York State Bar
Association Tax Section Report 1007, Simplification of the Internal
Revenue Code (March 18, 2002) and JOINT COMM. ON TAX'N, RECOMMENDATIONS
FOR SIMPLIFICATION, Vol. I (sources of tax complexity generally), Vol.
II (April 2001) (specific categories of issues).
I worry less about complexity for very sophisticated and rich
taxpayers (most MNEs, PE funds and portfolio companies and high net
worth individuals and trusts). I also would not give them elections.
_______________________________________________________________________
#4
Get rid of the individual and corporate alternative minimum tax.
Why should you have to calculate your tax, and then calculate it again
another way. If Congress does not like certain preferences, then they
should be eliminated.
For a while I filled out my father's tax returns. He lived in NJ, a
high-tax state. One spring I filled out his Form 1040 and calculated
his regular tax. Then I told him we had to fill out another form (6251)
to calculate whether he owed AMT. He was outraged. He said: ``I am 80
years old. I do not pay this alternative minimum tax.'' I said: ``There
is no exception for octogenarians.'' He said, ``You're fired!'' I said,
``You can't fire me. First of all, you aren't paying me anything to do
this. Secondly, I am your son--you can't fire your son.'' He said:
``You wanna bet? You're fired.'' In the end he owed AMT.
_______________________________________________________________________
#5
Another question is the type of complexity. Education incentives,
e.g., are easy to comply with--just plug everything into TurboTax and
see what comes out--but present complex incentives since no one really
knows how they're affected at the time of the expenditure. OTOH,
tracking deductible business expenses is complicated and time-
intensive, but the rule is easy to understand. Then, of course, there
are those provisions that just don't make sense and you need armies of
lawyers to interpret.
I think the original sin of most of the worst complexity in the
Code is the realization requirement--again, easy to understand, but
creates enormous problems.
_______________________________________________________________________
#6
I find the IRA rules to be unconscionably complex, particularly in
that the complexity falls on individual taxpayers. I would cite the
contribution limits, especially for retirement-plan participants
(section 219), eligibility for Roth contributions (section 408A), the
excise tax for getting the contribution limits wrong (section 4973),
the age 70-1/2 distribution requirements (sections 408(a)(6) and
401(a)(9)), the other distribution rules (section 408(d)), and the
numerous exceptions to the 10-percent early withdrawal penalty tax
(section 72(t)).
_______________________________________________________________________
#7
Some of the most complex areas of the U.S. tax rules pertain to the
taxation of foreign income. The following is a summary of some of these
complex rules. We can provide additional detail, if useful.
Foreign tax credits: There are highly detailed and complex rules
relating to foreign tax credits e.g., IRC 901-909.
Certain of the rules are designed to limit credits only to foreign
levies that are a tax on net income.
Other rules are designed to prevent the cross-crediting of high
taxes on one stream of income against another stream of low-
taxed foreign-source income.
Income and associated taxes are split into separate groups--so
called ``baskets'' (i.e., taxes in one basket cannot be
credited against income in another basket). Generally, income/
taxes are separated into a ``passive'' basket (which includes
dividends, interest, royalties, rents and similar income not
derived in connection with an active business) and a
``general'' basket (other income), with high-taxed passive
income (i.e., income subject to foreign tax in excess of the
U.S. rate) being excluded from the passive basket.
Intercompany dividends, interest, royalties and rents are
characterized on a ``look-through'' basis by reference to the
underlying earnings from which the amount is paid.
There are complex rules (the so-called ``splitter rules'')--
designed to address circumstances where the entity treated as
the taxpayer for foreign purposes differs from the entity
treated as earning the income for U.S. purposes. The purpose of
these rules is to match the income with the associated tax for
U.S. tax purposes.
This may arise, for example, where income is earned by an entity
that is fiscally transparent (e.g., a partnership) for foreign
tax purposes but that is treated as a separate corporation for
U.S. tax purposes.
This can also arise under foreign rules governing the taxation of
affiliated groups (e.g., one entity pays the tax on behalf of
the entire group; or losses are ``shared'' within the group).
There also are rules designed to address ``base differences''--
i.e., the tax base for foreign purposes differs from the tax
base for U.S. purposes.
Foreign tax credits are computed on a pooled basis for CFC's (with
foreign tax redeterminations treated as adjustments to the
pool) and on an accruals basis for U.S. taxpayers and for
foreign branches of U.S. taxpayers.
Excess foreign credits are carried forward up to 10 years.
There are complex rules governing losses--e.g., generally, if a
net foreign-source loss reduces U.S.-source income in one year,
subsequent foreign source income is re-characterized as U.S.-
source income. A similar rule is applied if a net loss in one
foreign tax credit basket offsets income in another basket, or
if a net U.S.-source loss offsets foreign-source income in a
year.
Interest allocation: There are highly detailed and complex rules
governing the allocation of U.S. interest expense to U.S.-source and
foreign-source income--e.g., 861, 864. These rules apply under current
law for purposes of computing net foreign source income in connection
with foreign tax credits. They also form the basis of the interest-
allocation proposal in the Administration's budget, denying deductions
for U.S. interest expense allocated to earnings of foreign subs (or
branches) that are not subject to U.S. tax.
Subject to certain exceptions, Interest expense is allocated to
U.S. and foreign-source income based upon the relative value of
the U.S.-group's U.S. and foreign assets. Income allocated to
foreign assets is then allocated among assets within each
foreign tax credit basket.
The value of U.S. and foreign assets is generally determined by
the U.S. tax basis in the assets. Taxpayers may elect to
determine the value of assets based upon fair market value--
which is a complicated and costly analysis.
In many cases, a complex analysis is required to determine the
type, or split, of income produced by an asset (e.g., an
intangible).
There are some complex (and incomplete) rules addressing the
treatment of certain types of interest equivalents, including
derivatives entered into as hedges.
There are complex rules addressing the treatment of intercompany
funding.
These include the so-called ``CFC netting'' rule-designed to limit
the creation of net foreign-source income through the
combination of U.S. borrowing and intercompany funding (i.e.,
U.S. interest expense is allocated between U.S. and foreign
income, and U.S. loans to foreign subs generally produce all
foreign source income).
Subpart F rules: There are highly detailed and complex rules
providing for the current U.S. taxation of certain types of income of a
CFC--e.g., IRC 951-961. This is generally income considered to be
passive or highly mobile.
This includes so-called ``foreign personal holding company
income''--e.g., dividends, interest, royalties, rents and other
similar income.
There are complex rules for excluding such income from taxation,
when derived in the course of an active foreign business. One
such provision, the ``active financing exception,'' is part of
the set of ``expiring provisions'' that have needed to be
reenacted on a regular basis.
Under another ``expiring provision,'' the ``CFC look-through''
rule, dividends, interest, royalties and rents paid between
CFC's are excluded from Subpart F if allocable to underlying
earnings that are not taxable under Subpart F.
Current taxation under Subpart F also applies to so-called
``foreign base company sales income''--which is generally
income of a CFC derived from (i) the purchase of property from
a related person or the sale to a related person, (ii) where
the property is manufactured outside the country in which the
CFC is located and the property is sold for use or consumption
outside the country.
There are complex rules for determining whether the property has
been ``manufactured'' in the country where the CFC is located--
e.g., whether the CFC has made a ``substantial contribution''
to the property.
And, there are rules for determining whether the property has been
sold for ``use or consumption'' in the country where the CFC is
located.
There are also complex rules applying similar principles to
branches of CFCs.
Similar taxation applies to ``foreign base company services''
income.
Comment:
If the U.S. adopted an exemption system (without a foreign minimum
tax), the complexity of the foreign tax credit rules would be
eliminated, except to the extended needed in connection with continuing
Subpart F rules (discussed below).
Similarly, complexity would be avoided if the exemption system did
not include interest allocation as a limitation on the deductibility of
interest expense. In part because of concerns about complexity, many
countries have opted for an exemption ``haircut'' (e.g., 5% inclusion)
in lieu of expense allocation.
Under an exemption system, there likely would be a continuing need
for the current taxation under Subpart F of passive foreign personal
holding company income. However, it's questionable whether the foreign
base company sales or services rules should be retained on foreign-to-
foreign transactions (i.e., the transactions result in a reduction of
foreign tax, not an erosion of the U.S. base). This would be another
area where complexity could be eliminated.
_______________________________________________________________________
#8
The ``straddle'' rules of Section 1092, which govern offsetting
positions. Especially complex are the ``mixed'' straddle rules, where
one of the offsetting positions is marked to market.
The New York State Bar Tax Section did a report in 2002 with some
examples of unnecessary complexity. It's at the following link.
http://old.nysba.org/Content/ContentFolders20/TaxLawSection/
TaxReports/100
7report.pdf.
They mention two more examples--the ``fractions rule'' and the
rules for netting capital gains.
_______________________________________________________________________
#9
The rules for corporate tax, partnership tax, tax accounting, and
insurance tax are other examples of extremely complicated tax rules.
Indeed, if I were asked to name the single most complicated and
difficult rule in the U.S. tax system, I might name the rule on
``deferred intercompany transactions'' under the regulations for
consolidated tax returns (the rule in Reg Sec. 1.1502-13). The standard
treatise on consolidated tax returns devotes approx. 400 pages to the
discussion of this single rule (the author of the treatise, an
extremely capable and talented tax lawyer, wrote the rule when he was
at Treasury's Office of Tax Policy).
_______________________________________________________________________
#10
There are a lot of insanely complicated corporate tax provisions,
but those usually don't get much sympathy because they mostly affect
corporations that hire Big 4 accounting firms to work out the results.
As to individual tax returns, but two obvious cases are the individual
alternative minimum tax and the passive loss rules (for the high
earners) and the earned income tax credit (for the low earners). Even
the AMT and passive loss rules don't get a lot of sympathy because
TurboTax automatically deals with a lot of the complexity.
_______________________________________________________________________
#11
Section 382 and its regulations are extremely complicated. To
determine whether use of a corporate NOL, capital loss or credit
carryover is limited, you have to determine if there was an ownership
change of the loss corporation, which is basically a more than 50%
shift in ownership over the prior 3 years. To determine if there is an
ownership change, you have to identify all 5% shareholders and
determine if their equity interest has increased in the past 3 years
and by how much. But if a corporation is owned by another entity or
entities, you have to look through the upper entities to look for 5%
shareholders and their ownership shifts. Besides the difficulty of
finding out who owns an upper tier entity (if that is possible), there
is a rule that says all less than 5% shareholders are together treated
as a single 5% shareholder whose ownership has to be tracked, but in
some cases you need to segregate these public groups into smaller
groups and track the smaller groups. Identifying and tracking ownership
shifts under the rules is very difficult, but the stakes are enormous,
because if there is an ownership change the use of attributes can be
severely limited or nearly wiped out.
To add to the complexity, the rules apply not only to NOLs, but
also built-in losses. If a corporation has assets with overall basis
greater than FMV, and it undergoes an ownership change, then if the
built-in losses are recognized within 5 years after the ownership
change, use of those losses are limited. So at the time of the
ownership change you have to know if the corporation has an overall
built-in loss and you have to know, for every asset you sell at a loss
within 5 years after the ownership change, whether that asset had a
loss in it at the time of the ownership change and the amount of that
built-in loss at the time of the ownership change.
And then there is the application of the section 382 rules in a
consolidated group. What a combination of two incredibly complicated
areas. Just scratching the surface of the additional complexity, for
example you need rules for members coming into and leaving a group.
There are few people who really understand the consolidated section 382
rules.
I also note that there are special AMT rules if a corporation
undergoes an ownership change.
Practice of tax law has gotten to the point where it is nearly
impossible to be a generalist. There is too much to know and it's too
hard to understand. It's not just federal tax law, it's state and
foreign tax law too.
And if you think it's hard for practitioners, think about how hard
it is for the IRS, which has to administer the entire Code, including
such varied programs as the EITC, energy provisions, FATCA and
healthcare.
_______________________________________________________________________
#12
Complexity is relative. Different situations merit different levels
of complexity; and the question is whether the rules are unduly complex
for the specific situation.
Take the U.S. partnership rules, for example. Over the years,
aspects of the partnership rules have been criticized for being overly
complex; and the IRS has issued revisions to the rules in part in
response to such comments. Much of the complexity in the partnership
rules, however, pertain to special allocations of income/losses. The
rules could be simplified by limiting special tax allocations. However,
the business and investor community would presumably object because
this would take away one of the principal benefits of operating in
partnership form.
Financial products is another area with complex rules. Here again,
there has been some criticism of the complexity of the rules. However,
the subject matter is very complex. A bigger issue with financial
products is that the products continually evolve; so there is a
constant issue of the rules needing to ``catch up'' with today's
products.
One issue that this discussion raises is the choice between
alternative types of rules. At one end of the spectrum are very
detailed rules applicable to specific fact patterns. This approach
provides certainty in the results of the fact patterns addressed, at
the risk of leaving open the treatment of other fact patterns. At the
other end of the spectrum is a limited set of rules that represent
guiding principles to be applied to different fact patterns. This
approach provides flexibility to address a broad range of fact
patterns, with less certainty in results.
It's interesting, because the consolidated return rules mentioned
in Marlin are, in concept, an example of the second type of rules. They
are designed to provide a limited set of guiding principles to govern
the taxation of intercompany transactions within an affiliated group.
However, the rules contain so many examples that the examples have come
to be viewed as largely defining, as opposed to illustrating, the
rules.
As far as complexity in the context of the international tax rules:
international business operations are complex, which suggests some
unavoidable level of complexity in the international rules. However,
there seems to be an opportunity to reduce the complexity in changing
to a new (exemption) system--which achieves other benefits as well.
_______________________________________________________________________
#13
There are certain parts of the tax code that are ``complex'' in the
sense of being very difficult because of certain conceptual challenges.
Subchapter K is a good example in my view. The total quantity of rules
is not great, especially when compared to other areas of the Code.
Instead, the complexity is generated largely by the fundamental
tensions between the aggregate and entity theories of partnership and
how that tension makes it so difficult to resolve a number of issues
(plus there are many issues that simply lack guidance). This is
difficult material to be sure, but not ``complex'' apart from the
extreme difficulty.
Another strain of complexity is found in areas of the Code which
are very formalistic and often contain multiple traps for the unwary.
Section 305 (stock distributions) is like that, as are a number of the
reorg provisions in subchapter C (which can be exceedingly
formalistic).
Perhaps more relevant are areas of the Code where there are these
intricate rules upon rules. These are areas where, instead of wiping
the slate clean and starting over again, Congress and/or Treasury
continues to layer floors and floors of rules upon a fundamentally
shaky foundation, so that the end result is a maze of rules that are
very hard to navigate. I think Section 382 (the section on trafficking
in NOLs) is one example--is that really such a big problem that we need
hundreds of regulations to combat it? But I think perhaps the best
example is the foreign area, where the entire process with Congress and
Treasury seems to be one giant ``whack a mole'' exercise. The 7874
rules that we discussed is a good example (with it having gotten so bad
that folks are now worried that totally innocent cross-border
transactions that aren't meant to be inversions can nonetheless get
caught by 7874). The 367 rules governing cross-border reorgs are a
monument to complexity--hundreds of pages of temp and regular regs that
do not mesh well at all and are remarkably confusing. The foreign tax
credit rules are another area, especially after the 909 splitter and
901(m) restrictions came into law.
_______________________________________________________________________
#14
What I find perplexing is that the Code is riddled with complexity
even for basic fact patters affecting the general taxpayer. It's hard
to build trust in the tax system when the average American needs to
hire an outside professional to prepare his/her tax return. I have
prepared tax returns for low income taxpayers who have to navigate
complicated rules such as the definitions for single/head of household,
dependents/qualifying persons, earned income credits and the litany of
other rules that should be basic law for someone who clearly has no
financial background. And, this permeates the entirety of the Code. It
affects us all because it feeds the notion that the tax law is rigged
and only benefits the business or person who can retain high priced
talent to benefit from ``loopholes'' in the system.
_______________________________________________________________________
#15
1. Allow small business greater use of the cash method of
accounting. The Bush Treasury allowed the use of the cash
method to a wide swath of small businesses. The Obama budget
has proposed expanding it to businesses with up to $25 million
of receipts. It would allow many small businesses to file their
taxes with little more than their checkbook registers of bank
statements.
2. Increase small business expensing. The Obama budget takes the
expensing limit up to $1 million. Combined with use of the cash
method, this proposal would represent significant
simplification for small business.
3. Repeal the uniform capitalization rules of section 263A and
replace with book capitalization rules. This one wasn't allowed
out of the building. Revenue estimators insisted it would lose
revenue. The accounting experts at Treasury insisted section
263A loses revenue because it invites companies to redo their
book capitalization, which inherently favors capitalization,
and to expense everything they possibly can.
4. Combine the multitude of tax preferred savings accounts into two
simple accounts, one for retirement savings and one for
everything else. We called the retirement account simply
``retirement savings account'' and the all-purpose account
``lifetime savings accounts.'' The accounts attracted more
excitement than any proposal I've ever worked on from Ph.D.
economists to ordinary Americans. I believe the proposals would
have been hugely beneficial for families of moderate means
because they were simple to understand and didn't require that
funds be set aside untouchable except for particular purposes,
which deters moderate income individuals from using tax
preferred savings vehicles at all.
_______________________________________________________________________
#16
Foreign tax credit provisions are incredibly complex. To claim a
foreign tax credit a firm has to (1) determine the payment to the
foreign government is a ``tax'' (i.e., a mandatory payment that is
generally applicable and for which it does not receive a ``specific
economic benefit''), (2) that the tax is an ``income tax'' in the U.S.
sense (i.e., you must apply U.S. tax principles to foreign law to see
if the tax is based on net income), (3) you must then determine the
amount of your (a) foreign source gross income and (b) your foreign
source deductions (by following a series of extremely complicated rules
set forth in the regulations . . . including separate allocation rules
for separate kinds of income--e.g., interest), (4) allocate the foreign
source income and foreign source deductions among various ``baskets''
(passive, active, high tax, oil related, etc.), (5) subtract the
allocated expenses in each basket from the income allocated to that
basket to determine the foreign source taxable income in that basket,
(6) determine the ratio of the foreign source taxable income in each
basket to worldwide taxable income to determine whether there is a
limit that applies to the allowable foreign tax credit, and (7) work
through any carry overs or carry backs of excess foreign tax credits
from prior years . . . and all the while make sure you are on the right
side of a broad set of anti-foreign tax credit stripping rules that
require an entity-by-entity determination of current income and
deductions, and historic pools of earnings and profits.
By contrast all of this complexity disappears under a territorial
system.
_______________________________________________________________________
#17
The complexity of some of the U.S. rules--e.g., regulations
relating to interest expense allocation--creates at least as much
difficulty for the IRS as for taxpayers and leads to real questions
about administratibility and fairness. Policymakers should have this in
mind in the context of tax reform, or in connection with multilateral
initiatives such as BEPS (where unadministrable rules can lead to
double tax and cross border disputes).
_______________________________________________________________________
#18
A few of the areas of areas of complexity worth noting are:
(1) The dual consolidated loss rules. It is a relatively brief
statute found at section 1503(d), but the regulations ate 1.1503(d)-1
through -8 are (as the citation suggests) very extensive.
(2) The overall foreign loss (``OFL''), separate limitation loss
(``SLL''), and overall domestic loss (``ODL'') rules are another good
example of complexity (and maybe an even better example of how
complexity inevitably breeds further complexity). You start with a
foreign tax credit system to prevent double taxation (which sounds
simple enough), but then you need FTC limitation rules to prevent using
credits to offset tax on U.S. income; that requires a universe of
income sourcing rules (a subject for another time). Then you need
different baskets of foreign source income to prevent ``inappropriate''
cross-crediting (and of course the number of baskets has ebbed and
flowed over time as perhaps further evidence of the battle between
``precision'' and ``complexity''). Once you have baskets and FTC
limitation rules you need OFL and SLL rules to preserve the integrity
of those categories ``across time.'' So taxpayers need to track all
their different items of income, ``source'' them, ``basket'' them, and
then track those categories over time using multiple OFL and SLL
accounts, with the result that once you have sourced and basketed
income you may have to re-characterize that income in any given year
based on what happened in prior years. Having done all that for foreign
losses to backstop the FTC limitation rules, it's only fair to have
overall domestic loss rules to ensure that taxpayers aren't
inappropriately denied credits over time. So the ODL rules are
introduced into the Code. And then you need extensive regs telling you
how all these pieces are supposed to fit together. For citation
purposes, the OFL and SLL rules are found at section 904(f) of the
Code, the ODL rules are in section 904(g), and the regulations are all
under 1.904(f)-1 through -12 and 1.904(g)-1 through -3.
(3) Another set of rules that we didn't discuss, but which are
extensive, ever-changing, and complex are the regulations under section
367. That Code provision is basically meant to override or turn-off the
non-recognition rules in certain cross-border transactions, and the
regulations under those rules are voluminous (to say the least), with
several outstanding Notices describing yet more regulations to be
written under those statutory provisions.
_______________________________________________________________________
#19
The number of tax brackets is not a source of complexity in itself
in an era of e-filing (though the lumpy effective marginal rate
schedule probably is), even though that's where the political rhetoric
goes. Also, the realization requirement, coupled with 1014, is perhaps
the biggest single source of complexity. It creates huge differences
based on character and timing, and so we then have numerous provisions
to police it. If we had mark-to-market, we could get rid of a corporate
tax, get rid of constructive sale rules and associated planning, tax
accrued gains at the same rate as ordinary income (thus minimizing
character issues), stop a lot of the debt/equity issues--maybe even get
rid of the estate tax, if we are otherwise effective at taxing inter
vivos wealth accumulation. So when people say mark-to-market is ``too
hard'' or ``too complex,'' I'm confused.
Here are some specifics on education. So many overlapping and
conflicting provisions that I think it's hard for a taxpayer to plan
effectively, and as a result I'm skeptical that these have much
incentive value. I think they are likely just pure redistributive
transfers, likely shared with the institutions.
Section 222 provides an above-the-line deduction for
qualified tuition, but only in certain situations, and with
discontinuous income-based caps and no phase-out or inflation
adjustments
The allowed deduction is also limited in cases where
the Section 25A credits apply and where the tuition was paid
out of a 529 account.
Section 25A provides for two somewhat overlapping tax
credits, the Hope Credit and the Lifetime Learning Credit, with
different benefits, applicability, eligibility, and inflation-
adjusted phase-outs.
These are somewhat simplified by temporarily making
the Hope Credit more generous (larger, refundable, slower
phase-out) and renaming if the American Opportunity Tax Credit
under Sec. 25A(i), but that expires 2018, so it will be subject
to the typical extender nonsense, probably not being resolved
until after students make expenditure decisions.
There are multiple forms of education savings accounts,
each with their own kludgy rules.
529s create gift tax issues and allow trades only
twice a year. Sec. 529(b)(4). I assume that's for paternalistic
reasons, but it also stops appropriate rebalancing.
u The state/federal structure is weird too.
There are also Coverdell Education Savings Accounts
under Sec. 530, with different rules, definitions of applicable
expenses (private school, not just college), more investment
flexibility, but income limitations that 529s don't have.
Let's throw in loans and financial aid while we're at it:
Pell Grants and subsidized loans that require
different eligibility determination, using FAFSA instead of tax
return
But IBR and PAYE loans also, which do use tax return
information.
u These also have political risk, including whether or
not forgiveness will be taxable.
Plus loan interest is deductible in some cases,
under Sec. 221, but with income phase-outs, etc.
_______________________________________________________________________
#20
Section 382 and the regulations is one of the most complicated tax
provisions.
Others that rank high in complexity:
1. Almost any Code section that requires resort to the Section 318
attribution rules, which apply to 8 other Code sections, per
the Code, and are incorporated by reference in some additional
places in the regulations.
2. Section 367, which changes/affects the result in exchanges
described in sections, 332, 351, 354, 356, or 361, as well as
certain other cross border or outbound transfers. subject to
exceptions included in the Code and the regulations, special
rules for partnerships, special rules for deeming certain
transfers to be ``exchanges,'' and special rules for transfers
of intangible property within the meaning of section
936(h)(3)(B).
3. Section 409A and a voluminous set of regulations which sets forth
some extremely complex rules governing the timing, form and tax
treatment of nonqualified deferred compensation payments. (For
example, the rules require meeting specific requirements
related to the time at which the initial decision to defer the
compensation is made, prohibiting any later changes to the
timing of the payments (i.e., they can't be further deferred
unless very strict rules are met, and they cannot be
accelerated), limiting the time at which payment can be made to
certain fixed events or dates, including death, disability,
termination of service, change of control, or a fixed date set
at the time the plan is adopted. . . . and each of these
payment dates (other than ``death'') has its own set of complex
definitions, rules and requirements.)
4. Alternative minimum tax for individuals.
Other sources of complexity for individuals include phase outs, the
multiplicity of rules applicable to pension and saving plans (e.g.,
traditional IRAs, Roth IRAs, profit-sharing and employee stock option
plans, 401(k) and 403(b) plans).
_______________________________________________________________________
#21
1. Limitations on the foreign tax credit.
2. The application of subpart F to partnerships
3. Expense allocation for purposes of determining the allocation of
deductions to foreign source income (relevant for foreign tax credit
limitation purposes).
4. Complex in a different way: application of the various anti-
abuse rules and doctrines in the code and case law, including the
economic substance doctrine.
5. The withholding and reporting rules on cross border payments,
including but not limited to FATCA.
______
Prepared Statement of T. Keith Fogg, Professor of Law and Director,
Federal Tax Clinic, Villanova University School of Law
getting correct returns
For low income taxpayers any trip into the arena of tax controversy
amounts to a loss. In general, they do not have the ability to
successfully navigate the tax controversy system. This system, however
well-intentioned and layered with protections, does not serve them
well. If low income taxpayers end up in the controversy system after
receiving a refund, the IRS also does not fare well. Even if the IRS
establishes a deficiency in tax, it will struggle and generally fails
to collect the tax once it goes out the door to a low income taxpayer.
Refundable credits create the greatest area of concern for low
income taxpayers, the IRS and the system in general. The decision to
use the tax system as a delivery mechanism for benefits places a great
strain on the tax system because it was not designed for this purpose.
The siren song of obtaining money from the government for the cost of
submitting a return, refundable credits, used to benefit low income
taxpayers, bring out identity thieves and fraudulent preparers who prey
on low income taxpayers and the IRS. The actions of these thieves, bad
preparers and fraudulent preparers draw low income taxpayers into the
controversy system and greatly complicate their lives. Once the IRS
begins the examination process, low income taxpayers must react
appropriately to a host of letters and notices that bewilder them.
Avoiding this situation provides a path to simplifying the system for
taxpayers who generally do not have the skills to protect themselves.
To simplify the system and the interaction between low income
taxpayers and the IRS, I would place great emphasis on getting it right
at the return filing stage. Instead of building a system designed to
issue a refund as quickly as possible and then deal with the
consequences of mistakes or fraud through the tax controversy system,
the system should emphasize competent tax return preparers or well-
designed software programs coupled with document matching to make sure
that the right amount of tax gets assessed at the outset and the right
amount of refund gets issued. If the returns received by the IRS
contain correct information and if the IRS processes those returns at a
time when it can verify the correctness of the information reported on
the returns, then identity thieves will no longer use the return
process as a source of revenue. If preparers are properly regulated,
particularly ones preparing returns with refundable credits, low income
taxpayers will not be victimized by the preparation process and wind up
in the controversy system.
In placing emphasis on the return filing point as the most critical
point in the tax system, my colleague, Les Book has put forth
principles that should guide decisions on how to the return process:
Does the provision promote desired behavior?
How does it relate to other provisions also intending to promote
compliance?
What are the taxpayer and third party costs?
Are compliant taxpayers/preparers bearing too high a cost?
Are the ``right'' noncompliant parties being identified?
Is the administrative determination readily susceptible to
challenge?
Does the provision allow IRS to efficiently administer its scarce
resources?
Is compliance readily ascertainable?
desired behavior
We want taxpayers to file accurate returns. We want to stop
identity thieves by making the return filing process unproductive for
them. We want return preparers or return preparation software to
perform in a manner that makes them the gatekeepers to the system and
assists taxpayers in navigating the system with the least cost and
inconvenience.
relationship to other provisions promoting compliance
We want a filing system that stops submission of incorrect data
without moving the matter downstream into the compliance system except
in rare cases. With respect to identity thieves, a system of matching
information prior to issuance of refunds will generally stop the theft.
Once the system demonstrates that filing the return does not bring the
desired reward, thieves will abandon the filing system unless and until
they can identity another opening. Delaying the issuance of refunds
until data matching occurs should significantly relieve downstream
pressure on compliance.
taxpayer and third party costs
Costs go beyond time and must reflect characteristics of community
being regulated. Low income taxpayers rely on their refunds to pay
bills. Delaying the refunds will delay bill payment. While the delay to
build a matching system brings a one-time delay not felt in subsequent
filing seasons, the timing of the refund can have other consequences.
Delaying the refund annually into the late Spring or early Summer could
impact the ability to pay certain time sensitive bills such as utility
bills for heat. Coordination with those providers and with other
providers on time sensitive matters would need to be a part of the
equation of moving the refund period.
Placing greater regulation on preparers would drive up their costs
and the cost to taxpayers using their services. The additional costs
may need to be considered in determining the amount of the refundable
credit in order to enable and incentivize taxpayers to utilize more
qualified and diligent preparers.
compliant taxpayer costs
The goal is to eliminate the reward that currently exists for
thieves and remove incompetent or fraudulent preparers. Return
preparation costs may increase and the refund may come later in the
filing season. Both changes could negatively impact compliant taxpayers
who have not had difficulties with the present system. Providing some
basis for offsetting the return preparation costs could take care of
the first problem. With greater savings from greater compliance,
perhaps a basis for providing taxpayers with this financial cushion
exists. Allowing a quicker refund to taxpayer using certain certified
preparers may eliminate the delay in receipt of the refund and provide
additional incentive to use qualified preparers.
identifying the right noncompliant parties
The noncompliant parties are known. Identity thieves will struggle
to profit in a system that tests information on the return against
third party data and returns filed by the ``real'' taxpayer prior to
sending out a refund. These individuals should largely get blocked from
refunds eliminating their incentive for filing and perhaps reducing the
number of returns filed once the matching system gains full impact.
Fraudulent preparers should have much greater difficulty operating in a
regulated system. If the IRS has authority to police the return
preparer population, it should largely eliminate the unscrupulous
preparers without the need to file injunction suits that stop people
after they have prepared inappropriate returns. The IRS also needs to
develop a more effective system for assisting taxpayers from preparers
who do get past the regulation and steal from them.
challenging the system
A system must exist for pushing back against the determination by
the IRS that has understandable legal standards--both to IRS and
taxpayer. Even though a well-defined and well administered tax
controversy system exists today, it places significant barriers to
success for low income taxpayers because it avoids human contact and
relies almost exclusively on correspondence and telephone contacts.
This method of addressing the problem does not work well for many low
income taxpayers who simply avoid and ignore a system not designed for
their problem solving skills.
Low income taxpayers need an accessible and clear way to
communicate with IRS about determination. Many times that way should
involve in person contact, but such contact does not exist for low
income taxpayers until they get to the Appeals Office or to Tax Court.
The IRS assigns individual agents to work larger cases involving
sophisticated taxpayers who could navigate the maze of phone and
computer options, but sends low income taxpayers to deal with employees
in phone banks who only touch the case once and cannot develop a
connection with the taxpayer. The system itself of requiring the least
sophisticated users to endure the most impersonal process creates many
of the problems for low income taxpayers. In both the examination and
collection phases of their case, low income taxpayers go from start
straight through to levy without a person assigned individually to
their case. They simply receive a series of letters requesting
information or directing action but they never hear from a person.
These letters provide little meaning or context to the problem for many
low income taxpayers and end up in a drawer or in a trash can.
Low income taxpayers need a clear path to court review of
administrative determination. The IRS provides them with information in
the correspondence it sends but makes it very difficult for them to
speak to someone who can explain the process or answer their questions.
They must wait for an hour or more to get through to someone on the
phone who may or may not have good skills at explaining the process and
guiding them to the steps they need to take to challenge a decision and
preserve their rights. The system relies on taxpayers understanding and
exercising their rights yet it has, through refundable credits, picked
up a populace with great difficulties in doing so. The IRS has made
some accommodations to assist these taxpayers after they fail to
properly exercise their rights, e.g., audit reconsideration; however,
it uses the system built for more sophisticated taxpayers to serve this
population. Neither Congress nor the IRS has not tried to build a
system designed to meet the challenges of this population that were
placed without request into the federal tax system.
effective use of scarce resources
As the IRS tries to manage more and more taxpayers and tax issues
with fewer and fewer resources, it seeks to rely more and more heavily
on automation and impersonal contact. This is a logical use of scarce
resources except that it often fails the low income population which
cannot adapt to systems and processes developed by the IRS for more
sophisticated users. While marshalling its resources for effective use,
the IRS and Congress must acknowledge that some taxpayers simply need a
personal touch. Sending letters, citing people to Internet sites and
having phone lines that do not get answered for long periods does not
serve a populace that cannot hire representatives to assist it with the
process and does not have the knowledge to navigate the system
effectively. A different system for using resources needs to emerge
even if it means fewer resources to do other tasks.
Having said this, the best use of scarce resources is preventing
problems in the first place by putting great emphasis on the
correctness of the return and enlisting return preparers and software
manufacturers to aid in the correctness through a mixture of
regulation, behavioral science and matching. At the outset of the case,
the IRS could rely on its computers and on outside resources to try to
prevent taxpayer problems that will draw upon its limited human
capital. Through this method, which may involve delaying the timing of
refunds to maximize the correctness at the outset, the IRS can more
effectively use its scarce resources. One model for using outside
resources to help insure the correctness of returns involves some form
of certification of the correctness of returns seeking refundable
credits. A certification process exists in the ITIN area for taxpayers
seeking an identification number:
One proposal to assist the IRS that has recently emerged involves
expanding the math errors procedures using the name correctable error.
This proposal raises concerns because it focuses on the back end of the
return process rather than the front end and it removes rather than
expands rights of low income taxpayers. It does address the scarce
resources concern at the IRS and seeks to truncate the audit process
but it does so at a cost to taxpayers who may have a legitimate claim
which may get lost in the new shorter process.
successful compliance outcomes
The most successful compliance outcome for low income taxpayers
results from keeping them out of the compliance process as a result of
their own mistakes or the willful or mistaken conduct of others such as
identity thieves or fraudulent preparers. While minor improvements to
the process might exist and will receive attention below, none of these
improvements will create a compliance process that will work well for
low income taxpayers.
To sum up this section of operating principles, I recommend certain
possibilities as a possible application of the principles as they apply
to returns containing refundable credits:
(1) Require a form of pre-certification of the returns and do this
through preparers who have obtained certification from the IRS
or through approved software programs;
(2) Do not allow preparers who have not obtained the proper
approvals from the IRS to prepare returns with refundable
credits;
(3) Do not issue refunds to taxpayer seeking refundable credits to
those who do not use properly approved preparers or properly
approved software until after the IRS has the opportunity to
load matching data and cross check the accuracy of the data on
the returns (or do not allow any refundable credit refunds
until the matching has occurred);
(4) Acknowledge that accuracy and not speed is the key to the
successful filing experience of a low income taxpayer seeking a
refundable credit;
(5) Provide some financial incentive to taxpayers to use the
properly authorized preparers or software to compensate for the
additional cost incurred
Other Provisions That Would Assist Low Income Taxpayers
in Tax Compliance
provide authority for the irs to regulate preparers
Clinicians operating low income taxpayer clinics see day in and day
out the ravages that poor and unscrupulous preparers cause to our
clients. The return preparation stage is the most important moment in
the process for low income taxpayers who do not have the resources or
savvy to engage effectively in the tax controversy process. Reverse the
decisions in Loving v. United States and Ridgely v. Lew and allow the
IRS and Treasury to regulate the industry that has such an important
impact on agency actions and on taxpayers in general. As mentioned
above concerning walk in sites, if we must bring low income taxpayers
into the tax filing system in order to obtain benefits, we need to make
sure we have designed a system that does not prey upon them. By
creating refundable credits, the system attracts individuals motivated
to get that easy money. These credits have created a paradigm shift in
the return filing process that must be acknowledged. The IRS finally
acknowledged the problem only to have its efforts stymied by the
Courts. Congress needs to step in to protect low income taxpayers and
the system in general.
provide a workable framework for assisting victims
of fraudulent preparers
We brought low income taxpayers into the tax system to deliver
benefits causing them to prepare, or have prepared, tax returns with
sufficient complexity to create problems many cannot navigate without
assistance. When the low income taxpayer has the misfortune to choose
the wrong preparer among the many unregulated preparers, these
taxpayers are being stuck not only without their refund but with the
bill created by the fraudulent preparers. The IRS has the authority to
abate taxes on fraudulent returns in which the taxpayer did not
participate and to refund to the taxpayer the correct amount of tax the
taxpayer should have received had the taxpayer not been defrauded. The
IRS has significantly dragged its feet in assisting these individuals.
After being defrauded and not receiving their refund or receiving
their refund and then being placed in the audit system, these victims
must endure audit process and wait years seeking resolution. The
adoption of a better filing system described above should eliminate
many of these problems going forward, but at this time many low income
taxpayer sit in victim's purgatory awaiting disposition of their cases.
The IRS is not moving on their corrected returns and has placed the
most vulnerable population of taxpayers in an untenable position. If a
taxpayer can demonstrate that they are the victim of a fraudulent
preparer, the IRS should establish a system of quickly moving to assist
them to remove assessments from their account and to restore their
correct refund. They should not receive bad treatment because they are
poor and made an unfortunate choice in the unregulated marketplace of
who to trust to prepare a return they do not know how to prepare
themselves.
provide taxpayers fighting identity theft and fraudulent return
preparation with adequate information
The IRS interprets the disclosure rules in a manner that can make
it very difficult for taxpayers victimized by identity theft to obtain
information about the theft of their identity and defend against the
consequences. If a taxpayer informs the IRS that a return using their
identifying information did not originate from the taxpayer, the IRS
declines to provide the taxpayer with that return citing the disclosure
laws. The disclosure laws should allow a taxpayer access to documents
using their tax identifying information. The ABA Tax Section has
proposed a legislative change that would address this problem and allow
individuals access to tax returns using the tax identification number
of the individual. A prior legislative proposal also sought to address
the problem although it placed discretion in the IRS to release the
information. Taxpayers whose identities have been stolen need access to
the information concerning use of their personal information. The
disclosure laws came into existence to protect taxpayers and not to
leave them uninformed and unprotected.
assist low income taxpayers in meaningful way when they interact with
irs
The IRS budget problems drive it to close sites where individuals
provide assistance to taxpayers and cause it to seek to provide more
services via the Internet. This does not work for many low income
taxpayers who do not have the access or skills to get the information
they need from the Internet. The IRS has not only closed or greatly
curtailed its walk in sites but its phone wait times have increased to
unmanageable proportions. Many low income taxpayers use track phones
and do not have the minutes to wait for someone to come onto the line.
If we decide to use the tax system as the delivery mechanism for
certain benefits previously delivered elsewhere in the government, we
must build a system that accommodates this population and not ignore
the fact that we have introduced millions into the tax system that
might not otherwise need to interface with the IRS. A part of using the
tax system to deliver benefits must include the necessary
infrastructure to service the population that does not operate as most
taxpayers in the system. The IRS must receive the resources necessary
to service this population in a meaningful way.
move slowly into process that reduces taxpayer rights
The concept of math error is rooted in a simple desire to quickly
and easily correct a return where the taxpayer adds 2+2 and gets 5.
That type of mistake deserves the treatment established in 6213 for a
letter to the taxpayer explaining the problem and a short time frame
for the taxpayer to point out their math was correct or allow
assessment of the correctly calculated amount. From that simply concept
has grown and panoply of provisions giving the IRS authority to make an
assessment without giving the taxpayer the direct opportunity to go to
Tax Court and contest the decision.
Recently, much discussion has centered on a further expansion of
math error to allow the IRS to administratively create adjustments
similar to math error now traveling under the more correct moniker of
correctable error. A proposal to give the IRS authority to expand these
provisions appeared in the General Explanation of the Administration's
Fiscal Year 2016 Revenue Proposals at pages 245-256.
For the reasons discussed above, fixing problems at the return
filing stage provides far better benefits to the system than fixing
those problems at the back end. The correctable error proposal would
allow the IRS to fix the problem at the end of the return filing stage
as it would normally transition to the examination phase. It will
reduce IRS resources in examining returns because it will allow the IRS
to send a correctable error notice when data on the return does not
match data in the IRS system.
Matching information before sending refundable credits should
occur. The correctable error proposal does not seem designed to stop
and correct the return prior to sending the refund. Although the IRS
will freeze refunds in many instances as it does today, the correctable
error proposal at its core appears to reduce exam resources for the IRS
and truncate taxpayer rights.
Matching before refunding should also reduce examination resources.
The goal of correctable error, in that respect, operates in sync with
the goal of matching before refunding. The problem with correctable
error comes with the truncation of taxpayer rights. A math error notice
(and presumably a correctable error notice) does not come with the same
explanations and rights as a notice of deficiency and does not come
with the same time frame. A taxpayer must determine what the notice
says and write back to the IRS within the 60 day time period in order
to avoid having the taxes assessed. If the IRS matches documents before
refunding, freezes any refundable credits (and possibly and paid
credits) not lining up with the documents available to the IRS, the
taxpayer should have the opportunity to test the difference in Court
after a full and fair opportunity to respond to the IRS concerning the
correctness of the items on the return.
The abbreviated protections afforded by math error should remain
the exception and not the rule. The IRS should give taxpayers the
opportunity for a meeting with an individual assigned to their case who
can review the information and make informed determinations. The goal
should be to swiftly make a determination because the taxpayer awaits a
refund which is crucial to their financial well-being, However,
swiftness should not mean an abbreviation of their rights.
While Congress has expanded math error authority over the years, it
has done so in a slow and deliberate manner. As it expanded the math
authority provisions Congress looked to ensure the benefits of reducing
taxpayer rights justified the expansion of the math error authority.
The correctable error proposal would pass that decision to the IRS.
Erring on the side of giving taxpayers more due process protections by
allowing them a day in Tax Court when a discrepancy exists regarding
data follows a path that should not harm the IRS if it holds the money.
Taxpayers engaged in identity theft or refund fraud are not likely
candidates to call upon the IRS or Tax Court resources to resolve their
problems. Once denied the initial quick refund, these parties will run
and hide seeking to avoid further identification and detection.
Taxpayers with legitimate concerns should get their opportunity to
explain the correctness of their return with full rights including the
presumptions created in IRC 6201(d) regarding third party information.
These procedures will fall disproportionately on low income taxpayers
who have the most to lose.
While we should look to create systems within the IRS that work for
those brought into the tax system because of its use to deliver
benefits, those systems should not seek to usher taxpayers out the door
without the opportunity for the full measure of their rights.
______
Questions Submitted for the Record to T. Keith Fogg
Questions Submitted by Hon. Orrin G. Hatch
Question. Mr. Fogg, you say in your written testimony that ``[t]he
decision to use the tax system as a delivery mechanism for benefits
places great strain on the tax system because it was not designed for
this purpose.'' Your testimony, however, then goes on to identify
methods within the context of the tax system by which to alleviate the
strain, such as pre-certifying returns, matching IRS data with returns,
and slowing the refund process and timeline. However, I did not notice
any mention of simply not delivering such benefits through the tax code
and identifying an alternative delivery method. Are you therefore
suggesting that the costs of delivering benefits through the tax code,
including these new mechanisms you identified, are outweighed by the
benefits? Additionally, would simplification of the tax code result
from relieving the tax system of a burden for which it was not
designed--the delivery of these benefits via refundable tax credits? Or
are you suggesting that some modifications to the current system for
low-income taxpayers will reduce complexity in the system and enhance
compliance and administration?
Does delivering benefits through the tax code provide an overall
benefit compared to another delivery system?
Answer. I did not mean to suggest that the costs of delivering
benefits through the tax code are outweighed by the benefits because I
have no basis for providing you with an informed judgment on the
relative costs and benefits. Use of the tax system to deliver benefits
can provide relatively low cost method of getting out money to low
income workers when everything goes smoothly. Others have thought about
and written on this subject from a comparative perspective. See, e.g.,
David A Weisbach and Jacob Nussim, ``The Integration of Tax and
Spending Programs,'' 113 Yale L. Journal 955 (2004) and David Gamage &
Darien Shanske, The Trouble with Tax Increase Limitations, 6 Alb. Gov't
L. Rev. 50, 57 (2013).
My point related to the impact on the tax system of using it as a
delivery mechanism for benefits and the impact of the use of the tax
system on the beneficiaries. Too often we focus on the ease of pushing
out the money without focusing on the back office operation that must
accompany the delivery system. The impact on the tax system has many
facets but I will focus on only a few. First, it requires the IRS to
devote resources to a social benefit program rather than its core tax
administration and collection function. If the IRS budgets shrinks but
the social benefit program does not, a greater percentage of the IRS
budget must necessarily be devoted to delivering social benefits
compared with collecting and administering the tax system.
Second, using refundable credits as the mechanism for delivering
the social benefits places a strain on the tax system because it
introduces into the system an additional source of errors and
noncompliance. Because of the refundable nature of these credits, they
attract parties to the tax process seeking to obtain money through
false pretenses and identity theft. These were not common problems in
the tax system prior to the introduction of these credits. For more
information on this issue see, Identity Theft: Trends and Issues, a
report by the Congressional Research Service available at https://
www.fas.org/sgp/crs/misc/R40599.pdf. If we choose to deliver benefits
through refundable credits, we need a tax system built to identify
false claims with a high degree of certainty. Having the IRS load
available third party data prior to processing returns would create the
necessary certainty to strongly combat the ID theft issue.
There is no research which suggest that the presence of refundable
credits itself is a driver for traditional tax compliance issues. In
addition to attracting identity theft, one problem with the earned
income tax credit (that it shares with small businesses) the presence
of variables that are not subject to information reporting, or
visibility. The lack of visibility to the IRS in the earned income tax
credit comes with the residence requirement. For more information on
this see the article published by the American University Law Review
available at: http://digital
commons.wcl.american.edu/cgi/viewcontent.cgi?article=1215&context=aulr.
This plays out with multiple parties claiming the same dependent. At
present, the IRS generally allows the first person claiming the
dependent to succeed while it blocks further persons claiming that
dependent. Because of the lack of visibility caused by the residence
requirement, the IRS operates blindly here giving the refund to the
earliest filer and throwing later filers into the audit stream.
Eliminating the race to filing that currently exists with the first
filing successfully claiming the dependent could be significantly
reduced by holding returns until the due date and then matching. While
the residence issue will remain opaque to the IRS, it will now have the
knowledge of all parties claiming the dependent at the time it goes to
award the benefit. This will allow it to make a more informed decision.
Third, the noncompliance occurring with refundable credits becomes
compounded by our visceral reaction to the payment of an improper
refund as a more important dollar loss than the failure to identify
underreporting of tax. This natural reaction seems to cause Congress to
direct the IRS to spend more energy chasing after or preventing the
lost refund dollars than much larger dollar issue surrounding the
underreporting of tax. This further removes the IRS from its core
mission of administering the tax system and collecting the most taxes
with the least cost. Flipping the filing season in the manner I
proposed would allow the IRS to more easily stop improper payment of
refunds. This, in turn, would free up its resources to focus on its
core mission rather than expend more time, energy and money
administering a social benefit program.
Problems also exist on the taxpayer side of the equation when the
IRS delivers social benefits.
First, low income individuals who would not become enmeshed in the
complexities of tax law and tax procedure get brought into the system
in order to obtain their benefits or as a result of improperly, or
allegedly improperly, obtaining benefits. The decision to use the tax
system as the delivery mechanism should include thought about the
difficulties these individuals will encounter as they interface with a
system not designed with them in mind. One example of the difficulty of
merging the tax system and the social benefit system occurs in the
refund arena. The tax system has a long held rule requiring full
payment before a refund suit may be brought. The full payment rule
stands as a significant barrier to access to the judicial system for
low income taxpayers caught up in a dispute with the IRS over the
correctness of the earned income tax credit where the taxpayer misses
the opportunity for judicial review in the only pre-payment forum, the
Tax Court. I have written on this topic previously for my blog, which
is available at http://www.procedurallytaxing.
com/refund-suits-divisible-taxes-and-flora-when-is-a-representative-
payment-representative-enough-part-1/.
Second, the tax system provides a significant burden to the low
income taxpayer when the IRS has inadequate staffing to handle the
issues created by placing social benefit programs on its plate. The
phone wait times to reach the IRS this year are extremely long and
provide a significant barrier to anyone who does not have significant
blocks of time during the hours when the phone lines operate and who
does not have unlimited minutes on their phone plan. The IRS does not
have convenient walk in locations, hours, staff, etc, to allow low
income taxpayers to walk into the IRS and sit down with someone to
discuss their problems. Due to its staffing problems, the IRS tries to
push out information through its web site; however, Internet access and
usage capabilities provide significant barriers to many low income
taxpayers who might want to make use of this resource. The IRS has
proposed further expansion of its math error authority which will
further reduce the protections of taxpayers brought into the tax
system. In short, low income taxpayers receiving benefits from the tax
system have no one to talk to when the system does not work and the IRS
seeks to further cut off their rights. If we use the tax system to
deliver these benefits, we must provide adequate resources to the IRS
to service this population as well as adequate protection of their
rights.
Third, forcing low income taxpayers to obtain their social benefits
through the tax system causes a high percentage of these individuals to
use paid tax preparers at a high cost to them because of the real or
perceived complexity of the tax system. Rather than working with
someone at a government office who does not charge for processing the
request for benefits, low income taxpayers receiving the benefits
through the tax system who lack comfort with the filing process must
use paid preparers (unless they can find a VITA or AARP volunteer.)
These preparers are currently unregulated and may prey on low income
taxpayers. Even when these preparers operate with ideal practices,
return filing and ancillary fees can significantly dilute the benefit
delivered. For more information on this point see http://www.nclc.org/
images/pdf/pr-reports/report-tax-time-products-2015.pdf.
My concerns with the current system can be addressed if we work to
eliminate the opportunities for improper claiming of refundable credits
by having the IRS load third party data prior to processing returns.
This should stop a high percentage of the improper claiming of benefits
from turning into refunds that the IRS must chase after in a process
that further dilutes its resources from core tax administration and
collection. On the taxpayer side, we should acknowledge that the cheap
cost of sending out money through the tax refund process comes with
back-end costs that need to be funded even if the IRS budget is
simultaneously being reduced. Phones lines must be properly staffed,
convenient walk in offices should exist both to assist in return
preparation and in responding to problems. Additional grants to promote
volunteer preparation or direct grants to assist in financing proper
return preparation should become a part of the system of delivering
these benefits through the IRS.
Question. Would simplifying tax code relieve the system of the
burden of delivering benefits?
Answer. Yes, simplifying the tax code could reduce the burden on
the tax system of delivering benefits through it. My previous written
and spoken remarks focused on simplifying the tax code as it pertains
to procedure and I will continue to focus on that aspect in my written
remarks; however, it is also true that simplifying the code to make it
easier to identify and claim the benefits would also help. For more
information on EITC issues see articles by the Joint Committee on
Taxation available at http://www.cob.sjsu.edu/nellen_a/papers/
EITCReform.pdf and a by the Center on Budget and Policy Priorities
available at: http://www.cbpp.org/cms/?fa=view&id=3445.
The primary focus of my remarks on simplification concerns changing
the focus of the return filing process from one designed to pay refunds
as quickly as possible to one designed to obtain the best possible
return and return verification process. Focusing on the correctness of
the return could greatly simplify the system for low income taxpayers
and the IRS by getting it right at the outset and avoiding the
difficult and costly tax controversy process.
First, this type of simplification requires a commitment to getting
things right as they come in the door. In some ways I think of this as
building a quality system or quality product as we have done with the
American automotive industry. In the 1970s our automotive industry did
not focus on quality in the product it built and it lost significant
market share to the Japanese who, using quality principles developed in
America, did build quality cars. Over time American car manufacturers
adopted quality techniques and now produce high quality products. We
need the same high quality product to be produced in the tax return
process and the same quality control at the IRS in initially reviewing
and verifying the return in order to simplify or tax system to one that
focuses on getting it right at the outset rather than pushing people
into a tax controversy process most low and middle income taxpayers
have significant difficulty in navigating.
Second, while simplifying the substantive tax provisions taxpayers
must address in preparing returns would certainly help, we need to
acknowledge that proper assistance with the return is a key to
preparing a correct return. Return preparers should have basic
competencies before being allowed to charge for their services and tax
preparation software should have design functions that lead taxpayers
to the proper result. Focusing on the individuals and programs that
lead to a correct return should greatly simplify the system and the
taxpayer experience in dealing with that system.
Third, the IRS should go into the filing season armed with the data
necessary to verify the correctness of returns prior to issuing refunds
rather than using available third party verification data to test
correctness after issuing refunds. The simple process of verification
with available data prior to issuing refunds should prevent significant
complexity in fixing the problem through the tax controversy system.
This is a relatively easy fix to reduce complexity from a technological
perspective but will require some retooling of our psychological
expectations with regard to the timing of the filing season and the
issuance of tax refunds.
Question. Will modifications reduce complexity?
Answer. Yes. I believe that the modification in the tax return
preparation process and filing process with reduce complexity for the
reasons discussed above. Even though we generally think of tax
simplification as modifying substantive tax code sections to reduce the
number of tests required to claim a particular benefit, I believe that
simplifying the process is also a form of tax simplification and
perhaps a more important form. In 1986 the reduction of the rate
structure was touted as major simplification. While laudable, this type
of simplification makes little difference given available software
programs. The big difference maker for low income taxpayers is keeping
them from getting caught up in a system where they must attempt to
interact with the IRS after the return process. These subsequent
interactions generally cost too much for them to afford representation
and present too many procedural, language and cultural barriers for
them to succeed. The subsequent interactions also put a strain on the
IRS which is trying to obtain information from a group that generally
does a poor job at responding. This often leads to assessment of
additional tax and 10 years of the collection process costing both the
IRS and the taxpayer years of ``complexity'' in the relationship trying
to fix a problem that should not have occurred in the first place. Once
in the collection system, the IRS is offsetting future refunds, sending
additional notices, filing notice of lien and complicating taxpayer's
lives in many ways that may not be apparent to someone focused solely
on simplifying the substantive code provisions.
Question. In Ms. Markman's written testimony, she says that one
area of tax law that is ripe for simplification is the rule requiring
taxpayers that have reached age 70\1/2\ to take annual required minimum
distributions (RMD) from all of their retirement accounts. If I
understand that point, a retiree with both a 401(k) account and an IRA,
a very common situation, must withdraw their annual RMD for the 401(k)
only from the 401(k) account, and the RMD for the IRA only from the
IRA. Ms. Markman suggests that we should allow a retiree to withdraw
the full RMD from either the 401(k) account or the IRA, as this would
be useful for retirees and would not result in any loss of tax revenue.
In light of the aging of the baby boom generation and the consequent
increase in retirement plan distributions system-wide, could you
elaborate on the complexity of the RMD rules and how this Committee
might help retirees by simplifying the rules, which I understand are
quite complex and which a retiree must grapple with every year?
Answer. I am not an expert in this area. My limited knowledge of
this issue comes from assisting elderly relatives in return
preparation. From that very limited perspective, I am uncertain that
having the RMD issued by one source would simplify the process because
doing so would require the individual to properly communicate with the
primary source about all of the other retirement accounts in order to
enable the primary source to properly calculate the RMD. It would also
require the secondary sources to know that they need not make the RMD.
Perhaps this level of communication is easier to achieve than I
anticipate. Assuming it is easy to get the various sources of
distribution to talk to each other, I agree that it is easier for the
recipient to receive the distribution from one source. My concern based
on my family members is that they have multiple sources of distribution
of relative small amounts and communication among these sources may not
always work smoothly.
Question. In Ms. Markman's written testimony, she comments on some
of the complexities associated with the various pass-through forms of
business entities, in particular partnerships and S corporations. Ms.
Markman specifically mentions that ``[i]n the interest of simplicity
and fairness, there should be one type of flow-through entity where the
owners enjoy the same benefits.'' Would you elaborate on your opinions
of this idea? More specifically, what would be some of the important
features of such a regime? In addition, what transition issues should
we be concerned with in a move from the current rules to this new
regime?
Answer. I am not an expert in this area and do not feel
sufficiently comfortable with the subject matter to be able to provide
you with meaningful input.
______
Prepared Statement of Hon. Orrin G. Hatch,
a U.S. Senator From Utah
WASHINGTON--Senate Finance Committee Chairman Orrin Hatch (R-Utah)
today delivered the following opening statement at a committee hearing
on simplifying the tax code:
The committee will come to order.
I want to welcome everyone to today's hearing to discuss
simplification of the tax code. I also want to thank our witnesses for
appearing before the committee today and for the written testimony they
have submitted.
This is the third hearing the committee has held to explore the
principles of tax reform embraced by President Reagan nearly three
decades ago. Those principles were efficiency, fairness, and
simplicity. We have held hearings on the importance of growth and
efficiency, and of fairness, in tax reform. Today, we will discuss the
problem of complexity in the tax code and the merits of simplification.
There are many sources of complexity in our tax system, including a
lack of clarity and readability, the use of the federal tax system to
advance social and economic policies, increased complexity in the
economy, and the interaction of federal tax laws with state laws, other
federal laws and standards, the laws of foreign countries and tax
treaties. The proliferation of credits, deductions, exclusions,
exemptions, fees, and excise taxes, all of which were presumably
intended by their proponents for good, also add to the overall
complexity of our tax system.
Over the years our tax code has grown to almost 4 million words.
Today, approximately 59 percent of American households use paid
preparers to do their individual income taxes and another 30 percent
use tax software to assist them. Taxpayers and businesses spend over 6
billion hours a year complying with tax-filing requirements with
compliance costs totaling over $168 billion annually.
That is larger than the entire economy of New Zealand.
That amount would employ more than 3 million workers full time at a
wage of $25 an hour.
Wouldn't that money be better off in the hands of hardworking
taxpayers, instead of devoted to complying with our overly complicated
tax code?
Imagine: A simpler tax code that greatly reduces compliance costs,
resulting in a tax code that is efficient, effective, and accountable
to taxpayers. In other words, a tax code that Americans can actually
understand.
As was noted in the comprehensive report on tax reform the
Republican staff of the Finance Committee released in December,
simplification often gets overlooked or relegated to secondary status
in the tax reform discussion. That should not happen. Complex tax
provisions--such as the personal exemption phase-out, or PEP, the
overall limitation on itemized deduction, or Pease, or the AMT--
effectively force taxpayers to seek costly help from professional
preparers.
Complexity should be a matter of concern for tax policymakers
because it makes it more difficult, time-consuming, and expensive for
taxpayers to comply with the law and for the IRS to enforce it.
Complexity also reduces perceptions of fairness in the tax system and
can decrease voluntary compliance with the tax laws.
But, of course, simplification is not without its trade-offs. For
example, there is often a tension between fairness and simplicity.
Simple statutes may not be fair because they lump together taxpayers
who, in fairness, should be treated differently. And statutes that
comprehensively address relevant distinctions between taxpayers,
leading to fairness, tend to be more complex.
But, no one said tax reform would be easy. These tensions and
tradeoffs come with the territory and should not deter our efforts.
Today we will hear from four witnesses on the front lines of the
tax reform debate and we look forward to discussing with them the pros
and cons of simplification of the tax code.
I will now turn to Ranking Member Wyden for his opening remarks.
______
Prepared Statement of Carol Markman, Certified Public Accountant and
Director of Taxation, EP Caine and Associates CPA, LLC
I am Carol Markman, a CPA from Westbury, NY. I am Director of
Taxation for EP Caine & Associates, CPA LLC of Bryn Mawr, PA. For over
35 years, I have worked with individuals and small businesses
specializing in taxation.
I currently serve on the Tax Executive Committee of the American
Institute of Certified Public Accountants and previously served a 3-
year term as a member of the Internal Revenue Service Advisory Council
(IRSAC). I am a Past National President of the National Conference of
CPA Practitioners, NCCPAP, the only professional organization focused
on representing Certified Public Accountants in Public Practice, and a
past chairperson of its Tax Policy Committee. Accompanying me is
Stephen Mankowski, CPA, a partner of EP Caine & Associates , CPA LLC of
Bryn Mawr, PA and the National Executive Vice President of NCCPAP and
the current Chair of the NCCPAP Tax Policy Committee.
Thank you for your invitation to speak at this hearing on the
merits of simplification in tax reform. Simplicity is a lofty goal in
tax reform that many of us would like to see, however, simplicity
frequently leads to unfair and/or unreasonable outcomes. For example,
the simplest type of tax is a sales tax but it is the most regressive
type of tax since it places the highest proportionate burden on those
least able to pay the tax.
I have chosen to speak about several areas which I believe cry out
for simplification paired with fairness and equity:
Retirement plans
Education incentives
Definitions in the tax code, in particular modified adjusted gross
income
Allowable mileage rates
Different forms of business entities
retirement plans
There are many different types of retirement plans; 15 are listed
on the IRS website. Many taxpayer have more than one type of plan when
they reach age 70\1/2\. This age is important because at 70\1/2\
taxpayers must begin taking an annual required minimum distribution
(RMD) from all of their retirement plans except if they are currently
employed by the organization that is the sponsor of the plan or their
account is a Roth Individual Retirement Account (Roth IRA). The amount
that must be withdrawn is based on the account balance at the end of
the immediately preceding calendar year, the plan owner's age during
the current year and a factor from one of two IRS approved tables
depending on the age of the beneficiary.
One area of tax law that is ripe for simplification is the rule
requiring a taxpayer to withdraw an RMD from each type of retirement
account. Once the Individual Retirement Account (IRA) owner calculates
the RMD for each IRA that he or she owns, the IRA owner can withdraw
the total amount from one or more of the IRAs. Similarly, a 403(b)
contract owner must separately calculate the RMD for each 403(b)
contract that he or she owns, but can take the total amount from one or
more of the 403(b) contracts.
However, RMDs from other types of retirement plans, such as 401(k)
and 457(b) plans, have to be taken separately from each of those types
of plan accounts.
This begs the question: Why is it necessary to take an RMD from
each type of retirement account? A taxpayer may have a small 457(b) and
a large IRA. Perhaps they would like to take the RMD from the entire
balance of the small 457(b) and the balance, if any, from the IRA
account. Why not permit this? This change creates simplification with
no reduction in tax revenue.
Another issue regarding retirement plans is the ten percent penalty
for early withdrawal from a plan. There are 12 different exceptions to
the additional tax on distributions before age 59\1/2\. However,
different exceptions apply to different types of retirement accounts.
For example, the exception to the imposition of the penalty for
qualified retirement distributions made to an alternate payee under a
qualified domestic relations order (an order by a judge made to divide
a retirement account in connection with a divorce) does not apply to
IRAs. Another exception to the penalty is for an IRA distribution made
for qualified higher education expenses. This provision does not apply
to other types of retirement plans.
It is my recommendation that the penalty exceptions to the
additional tax on early distributions from retirement plans be uniform
across all types of plans.
education incentives
There are many incentives in the tax law to encourage post
secondary education; some are to encourage taxpayers to save for
advanced education, some incentives apply while the student is
attending school and there is another for the interest on student
loans. Many of the incentives have different income phase outs,
different limits on the number of years the benefit is available, the
number of courses the student must take, what type of expenses qualify
for the incentive among others.
Many of the benefits are per family rather than per student. If a
family has more than one child in college at the same time, some
colleges actually provide additional aid to the family. However this
aid it is not necessarily sufficient enough to offset the combined
costs of tuition and other higher education related costs for multiple
children in college at the same time. These per-family limits on
benefits are very unfair and place additional stress on the family
budget.
Some of the benefits are available for a specific number of years
but some college programs such as a Bachelor's degree in accounting are
required by some states to be 5 year programs. Also some students are
not able to carry enough credits so that they can graduate in the
expected number of years because they must work while going to college.
The phase-out of the benefits for high-income taxpayers should be
made uniform across all similar incentives and there should be a
separate phase-out for taxpayers filing as Head of Household (HOH).
Currently the phase-out for taxpayers filing as HOH is the same as for
single taxpayers but their family financial circumstances are
frequently very different. Many taxpayers filing as HOH are raising
their children on their own with little or no other support.
There is a need to coordinate the various education incentives so
that the benefits are available to the desired taxpayers with less
confusion. Fewer tax provisions with uniform phase-outs, per-family
limits, and types of allowable expenses would go a long way to
simplifying these provisions. A computer should not be needed to
determine which education benefits apply and which ones provide the
best tax result for a taxpayer.
modified adjusted gross income
There are many definitions of Modified Adjusted Gross Income (MAGI)
that factor into the preparation of individual income tax returns. MAGI
are determined by adding back certain items to the individual's
Adjusted Gross Income (AGI).
The difficulty is determining which items of income or deductions
are added back. This varies with the provision in the tax code for
which MAGI is being calculated. Items such as foreign earned income,
foreign-housing allowances, student-loan deductions, IRA contribution
deductions, passive losses, adoption expenses, and deductions for
higher-education costs are add-backs for some tax provisions but not
others. I have identified 17 add-backs and items not taken into account
and two subtractions that are needed for one or more MAGI calculations.
I have prepared a chart of some of the more common addback and
subtractions, which is attached to this testimony.
The calculation of MAGI is a factor in various calculations
including, but not limited to, determining education benefits, who is
allowed to make certain types of IRA contributions, the special
allowance for real estate professionals, whether a taxpayer has to pay
higher Medicare Part B and Part D premiums, the Affordable Care Act
Premium Tax Credit and the Health Coverage Exemptions, among others.
MAGI is also used to determine how much of a taxpayer's Social
Security Benefits are taxable, and whether a taxpayer is eligible for
the adoption tax credit, the retirement savings credit, and/or
education tax deductions or credits.
The IRS has a relatively simple MAGI calculator on irs.gov, but
this calculator can only be used to calculate MAGI for Passive Activity
Loss computations with knowledge that it is for this purpose and no
other.
These varying definitions greatly add to the complexity of tax
return preparation so that it requires a computer to calculate MAGI in
many instances. It would aid in simplification if MAGI for similar
provisions could be made uniform. For example, why are non-taxable
Social Security benefits an item that must be considered for MAGI in
order to make a Roth IRA contribution but not for a Traditional IRA
contribution when neither type of IRA contribution is tax deductible?
allowable mileage rates
There are several allowable mileage rates available to taxpayers
for claiming deductions in connection with different types of travel:
business mileage, mileage to obtain medical care, mileage when moving
for a change in employment, and mileage while performing charitable
activities. All except the charity rate are annually set by the IRS.
The charity rate was set by the Congress prior to 1984 and has not been
changed since that time. Other Federal agencies, such as the General
Services Administration (GSA), also set mileage rates.
A comparison of the 2015 IRS rates for tax deductions purposes and
the GSA reimbursement rates is interesting:
GSA
IRS Reimbursement
Business mileage--personal auto 0.575 0.575
Business mileage--government auto N/A 0.23
Medical care and moving mileage 0.23 N/A
Charity activity mileage 0.14 N/A
It does not make economic sense that the rate for charitable
activities has not increased in 30 years. Today, that rate is
significantly lower than the rate for moving and medical care.
Taxpayers view this difference as unfair since many more people can
claim mileage for charity than can claim mileage for medical care.
different forms of business entities
The various forms of business ownership, which include
partnerships, limited liability companies (LLC), limited liability
partnerships (LLP) and corporations, are governed by state laws, rules
and regulations. The principal forms of business operations for tax
purposes are sole proprietorships, partnerships, S corporations and C
corporations. LLCs and LLPs can elect to be taxed as a partnership, S
corporation or a C corporation. LLCs are a hybrid type of business that
combines features of a corporation with the operational flexibility
available to partnerships. LLCs did not come into existence until 1977.
Sole proprietorships, partnerships, S corporations and C
corporations are all taxed differently. Sole proprietorships can have
only one owner (unless the second owner is the owner's spouse) and are
the simplest form of flow-though entity. The net income from a sole
proprietorship is taxed at individual rates and subject to self-
employment tax. Retirement plan contributions for a sole proprietor are
not deductible in the calculation of the owner's self-employment tax.
Partnerships and S corporations are also flow-through entities
where the net income is taxed to the partners or the shareholders,
whether or not there are funds available to make distributions of the
profits.
Partners are not permitted to receive their compensation as wages.
Partnership compensation is in the form of guaranteed payments or
distributions from the partnership and all partnership income is
taxable at individual rates and subject to self-employment tax.
Retirement plan contributions for the partners are not deductible in
determining self-employment tax.
S corporation shareholders can receive compensation from the
corporation in the form of wages. Retirement plan contributions for the
shareholders are deductible by the corporation and reduce the FICA tax
on the shareholder's wages.
Another challenge is that many businesses that began as
corporations want to convert to LLCs but cannot do so because of the
adverse tax consequences as a result of such a conversion. Flow-through
entities account for nearly 95 percent of all business entities in 2008
according to a 2011 report issued by Ernst & Young.
In the interest of simplicity and fairness, there should be one
type of flow-through entity where the owners enjoy the same benefits.
One area that can be simplified--at no cost--concerns the rules
regarding the deduction for self-employed health insurance by S
corporation shareholders with more than two percent ownership.
Currently the S corporation is required include the health insurance
premiums in wages. The premiums paid by the corporation are reported on
the taxpayer's K-1 from the S Corporation. The taxpayer can deduct the
health insurance premiums as an adjustment to arrive at Adjusted Gross
Income. The net affect is that more wages are reported on the W-2 but
the taxpayer gets a full deduction for the health care premiums, with
no change in taxable income.
The simplified procedure would be for the S corporation to pay and
deduct the health care premiums and no deduction on the shareholder's
individual income tax return. There would be no impact on the taxable
income of the taxpayer and no change in the shareholder's taxes.
Thank you for the opportunity to present this testimony.
Respectfully submitted,
Carol Markman, CPA
Definitions of Modified Adjusted Gross Income
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
Education
Medicare credits
Premiums American Tuition & Education Form 8582 Form 8962
Increased Traditional Roth IRA Opportunity Student loan Fees savings Passive Premium tax Form 8965
for High IRA Coverdale interest deduction Bonds activities credit ACA penalty
income IRA Lifetime
Learning
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
Addbacks to Adjusted Gross Income:
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
Deduction for IRA contribution X X X
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
Deduction pension plan contribution X
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
Deduction for deductible part of self-employment X
tax
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
Passive income or losses X
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
Real estate losses allowed to professionals X
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
Exclusion for income from U.S. savings bonds X X X X
used for education
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
Exclusion for adoption expenses X
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
Student loan interest deduction X X X X X
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
Overall losses from PTP X
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
Taxable Social Security X
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
Tuition and fees deduction X X X X X X
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
Domestic production activities deduction X X X X X
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
Excludible employer-provided adoption benefits X X X
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
Non taxable Social security benefits X X
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
Tax exempt interest X X X
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
Exclusion for foreign earned income & housing X X X X X X X X
Pallowances
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
Income from Puerto Rico & American Samoa X X X X
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
Subtractions from Adjusted Gross Income:
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
Income resulting from the conversion of an IRA X
(other than a Roth IRA) to a Roth IRA
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
Rollover from a qualified retirement plan to a X
Roth IRA
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
Prepared by Carol Markman, CPA for the Senate Finance Committee hearing on ``Tax Complexity, Compliance, and Administration: The Merits of Simplification in Tax Reform''--March 10, 2015.
______
Questions Submitted for the Record to Carol Markman
Questions Submitted by Hon. Orrin G. Hatch
Question. Ms. Markman, in your written testimony you say that one
area of tax law that is ripe for simplification is the rule requiring
taxpayers that have reached age 70\1/2\ to take annual required minimum
distributions (RMD) from all of their retirement accounts. If I
understand your point, a retiree with both a 401(k) account and an IRA,
a very common situation, must withdraw their annual RMD for the 401(k)
only from the 401(k) account, and the RMD for the IRA only from the
IRA. You suggest that we should allow a retiree to withdraw the full
RMD from either the 401(k) account or the IRA, as this would be useful
for retirees and would not result in any loss of tax revenue. In light
of the aging of the baby boom generation and the consequent increase in
retirement plan distributions system-wide, could you elaborate on the
complexity of the RMD rules and how this Committee might help retirees
by simplifying the rules, which I understand are quite complex and
which a retiree must grapple with every year?
Answer. Under current law a taxpayer must begin to withdraw a
Required Minimum Distributions from all retirement plans by the April
1st of the year following the year they become 70\1/2\ except of the
taxpayer is still working for the company sponsoring the retirement
plan and the taxpayer is not a five percent owner of the business.
The first complication is the age of 70\1/2\. It would be much
better if the age was 71 or it would be even better if the age was 75
as people are living longer.
The second is the subsequent year April 1st deadline for the first
required distribution. Taxpayers do not always realize that if they
delay their first distribution to the April 1st of the year following
the year they become 70\1/2\, they could be required to take two
required minimum distributions in that year. This could have an impact
on the taxable amount of their Social Security benefits, the amount of
their allowable deduction for medical expenses and other deductions. I
suggest that the first distribution be required in the year in which a
taxpayer turns 71, period.
A third complication is the charts that the IRS has developed. The
Uniform Lifetime chart must be used by most retirement plan owners.
However, there is an alternative chart that is to be used if the
beneficiary is a spouse who is more than 10 years younger and the sole
beneficiary of the retirement plan owner. There is a third chart that
must be used by beneficiaries of retirement plans and there are
different rules entirely if there is no designated beneficiary. Perhaps
there some way to simply the charts or at least require the IRS to
develop an online calculator. To date there are various online
calculators developed by brokerages, banks and other organizations but
none are authoritative.
Another issue is that the IRA beneficiary distribution rules are
different based on whether the retirement plan owner died before or
after the required beginning date. One set of rules would be helpful.
Question. Ms. Markman, in your written testimony you noted that ``.
. . many businesses that began as corporations want to convert to LLCs
but cannot do so because of the adverse tax consequences as a result of
such a conversion.'' Is the effect of double taxation the driving force
behind the desire to convert? What are the other drivers of the desire
to move from corporate to pass-through status, and how does
simplification from the perspective of the business owners and managers
factor into that decision? Also, please highlight for us some of the
important tax and non-tax considerations that you see in practice with
your business clients that make such a change difficult?
Answer. No, I do not think double taxation is the issue as the
owners of the corporations that have lamented that they cannot convert
to LLC are corporations that have elected to be taxed as S
corporations. I think the desire to convert to LLC status is to allow
the business to be taxed as a partnership. Before LLC were permitted
under state laws, partners in partnerships had unlimited liability.
Partnerships offer a lot more flexibility than S corporations.
Once a business is organized as a corporation, conversion to a
partnership carries significant tax consequences, specifically the tax
on built in gains of assets that have appreciated.
Some of the reasons why businesses may want to convert:
LLC statutes in terms of administration are much simpler and more
forgiving. Corporations require annual meetings, board
meetings, etc. LLC does not require any of that as a Member ran
LLC can simply designate authority to a Manager.
Many businesses formed prior to LLC in 1990 have been stuck. They
could not convert to be S corporations prior because their
ownership was not agreeable to making an election to be taxed
as an S corporation or they were not eligible to be taxed as an
S corporation (35 shareholders back then but mainly just
ineligible shareholders owning the stock such as corporations
which are not allowed to own stock in S corporations and non-
resident aliens). Even though they wanted to have the advantage
of a single level of tax but they could not do so because of
ownership issues.
Conversion to a partnership from C corporation gives current
owners more flexibility in allocating profits to more closely
recognize economic business relationships.
Conversion to a partnership from C corporation would allow
existing businesses to more easily facilitate mergers with
appreciated property (any contributions of appreciated property
to a C corporation that fail the control test will also be
taxable whereas under subchapter K this will not be the case).
Even if a business is going to convert and be responsible for the
tax, most would have to value the assets of the C corporation
business to correctly assess tax.
Question. Ms. Markman, in your written testimony you comment on
some of the complexities associated with the various pass-through forms
of business entities, in particular partnerships and S corporations.
You commented that ``[i]n the interest of simplicity and fairness,
there should be one type of flow-through entity where the owners enjoy
the same benefits.'' Would you shed a bit more light on this idea for
us? More specifically, what would be some of the important features of
such a regime? In addition, what transition issues should we be
concerned with in a move from the current rules to this new regime?
Answer. Many people who form business entities believe that there
is status in not operating as a sole proprietorship. In New York it is
less expensive to form a corporation than an LLC because of the
advertising requirement. So people choose to form corporations and then
elect S status, thus achieving pass-through status. This works for many
businesses but operational mistakes are made. For example, I have seen
situations where a business is formed as an LLC and then pays wages to
the LLC members, which is not permitted. Another example is when a
shareholder in an S corporation needs to receive a distribution from
the corporation to pay taxes on the S corporation income and the other
shareholder has their own resources to pay the taxes. This is currently
not permitted.
Any new type of business entity should provide the most flexibility
in order to aid business and economic activities. Some issues to
consider are:
No limit on the number of owners.
Owners can receive income as salary subject to withholding taxes
if desired and they provide services to the business.
Allow check the box election for tax status so that the business
could elect to be taxed as a corporation or to be a disregarded
entity if it has only one owner.
Will fringe benefits including health insurance and Social
Security taxes for owners be deductible by the business entity?
Will all net income be subject to self-employment tax?
Will net income be subject to the net investment income tax?
This would require cooperation by the states to recognize this new
type of entity and its flow-through status.
Some transition issues are:
How will S and C Corporations be taxed on non-liquidating
distributions?
How would debt recapture for partnerships primarily that are being
funded on debt basis be handled? This could cause phantom gain
recognition if the business entity would be converted to an S
corporation like regime.
Would S corporations still subject to the built in gains tax after
conversion from a C corporation?
How would partnerships that currently have capital account
percentages different from profit/loss percentage be handled?
How will tiered flow-through entities be handled? Right now there
can be multiple tiered entities, which sometimes makes tracing
the income to the ultimate taxable individual very difficult.
Also, not all states permit tiered flow-through entities.
______
Prepared Statement of Hon. Ron Wyden,
a U.S. Senator From Oregon
If we opened up the hearing room curtains and looked outside, we'd
see that the gloom of winter has finally lifted. But instead of
enjoying the beginning of spring, millions of Americans are stuck
buried under mountains of tax forms, documents, and receipts. Around
this time of year, I start to hear from Oregonians that they're sick
and tired of this painful process of filing taxes. I am right there
with them.
Our tax system has become so incredibly complicated, even somebody
who really knows her way around an accounting textbook has a hard time
getting everything right.
The fact is, our overcomplicated tax code divides taxpayers into
very different worlds. There are the lucky few who can afford to hire
tax pros to game the system with ``wash sales,'' ``options collars,''
and ``swap contracts''--activity detailed in a report I released last
week. Then there's everybody else just trying to put their tax return
in the rear-view mirror.
It's a whole lot harder to use the code to your advantage if you're
a middle-class individual, a small business owner, or a family just
getting by. For example, when a family needs help paying for higher
education, there are more than a dozen separate tax incentives to wade
through. As if that wasn't complicated enough, each provision has its
own set of rules and definitions. The term ``small business'' is
defined more than 40 different ways in the tax code. There are even at
least four definitions of a ``dependent,'' which is what most of us
know as a ``child.'' And too often, simple errors on these and other
tax breaks aimed at the middle-class or low-income families are labeled
as fraud.
So to avoid the hours and hours of paperwork, a lot of taxpayers
look elsewhere for help. Many turn to software online, but they often
end up spending a big chunk of their refund just to file. And as we
learned this year, there's always a security risk filing with software.
So a lot of other taxpayers look to return preparers. But again, that
can be a big financial hit. Even worse, it exposes people to
incompetence and abuse by unscrupulous return preparers who don't have
the customer's best interest at heart. That's why Senator Cardin and I
introduced the Taxpayer Protection and Preparer Proficiency Act this
year--to protect taxpayers by setting minimum requirements of
competence for preparers.
In the end, comprehensive tax reform is the best way to simplify
our tax system across the board. Some people say that it's impossible
for tax reform to make the tax code simpler and fairer to everybody at
the same time. But I don't buy it. Simplification and fairness are
cornerstones of any serious tax reform plan. That's why they're at the
heart of the bipartisan plans I developed with Senators Gregg and
Coats. Under those plans--which protected low-income and middle-class
families--most people would file their taxes on a single, one-page
form. When Money Magazine tried it out, it took a matter of minutes to
complete a typical return, not hours.
Comprehensive reform won't iron every wrinkle out of the tax code,
nor should it. But the experience taxpayers go through every spring
doesn't need to be such a nightmare. So let's look at tax reform as an
opportunity to get people out from under all the paperwork and give
springtime back to taxpayers. I'm looking forward to discussing how to
do that with our witnesses today.
______
Communications
----------
Letter Submitted for the Record by Dixie Hickman Cole
Gymea Bay, N.S.W. 2227
Australia
2 March 2015
Senate Committee on Finance
Attn. Editorial and Document Section
Rm. SD-219
Dirksen Senate Office Bldg.
Washington, DC 20510-6200
Fax: 0011-1-202-228-0554
To Whom It May Concern:
I was born in the U.S. and came to Australia after University on a
teacher's contract. I met my husband and decided to immigrate. I have
had my full teaching career here, as well as my family of 2 daughters
and now they have married and I have 2 grand-sons. I decided after the
same number of 22 years living in Australia as I had the U.S., to
become an Australian citizen. My life is fully here now. Both my
parents are deceased and I only have two much older sisters in the U.S.
I have worked very hard in my career while in Australia, teaching
Students with Special Needs, becoming an Assistant Principal and even
receiving an Order of Australia medal, for my work with such students.
During that time I thought that I had planned my Superannuation to make
sure I would be financial in retirement, not asking of the government
in a pension, and trying to cover for possible needed nursing home
care, my funeral, etc, as not to be a burden as well on my children,
and not knowing how long I will live, for my Superannuation to last.
I never expected, and certainly never planned on the U.S. government
deciding to take 15% of it away, which over the time of the rest of my
life, will add up to a lot of money, that I may need for the items
mentioned above. Otherwise, I may have been able to make different
plans in someway to cover for this, but to have it happen after you
have retired, there is no way now to compensate for this.
I feel this may be legal in the perception of the U.S. government,
considering the treaty is to not double tax, citizens residing outside
the U.S., and since in Australia, as of 60 years old, our
Superannuation is not taxed. The U.S. then thinks they have the right
to tax us, even in my case though I have not lived in the U.S. for 40
years. I do not feel I owe the U.S. this tax, since I have had no
benefits from the U.S. in anyway, in all that time.
I feel this is grossly unjust, unfair and immoral, especially since I
have always tried to do the right thing and file a U.S. tax report each
year, done by a proper Accountant who deals with U.S. tax, which in
itself has cost me quite a lot over the years.
I understand the debt the U.S. is in, but is it so low that it has to
hit its U.S. citizen retirees who have for most of their life resided
in another country and who are just trying to financially live out
their years that are left. I lost my husband to cancer 5 years ago, and
through the grieving have suffered physical health problems as well as
depression, and anxiety. I did not need the stress and worry of knowing
that I was going to lose 15% of my Superannuation as well.
Hoping the U.S. government will review this decision, when
understanding the hardship in lots of cases that it is causing.
Dixie Hickman Cole
______
Letter Submitted for the Record by Martha Henderson
Engadine NSW 2233
Australia
The Honorable Senator Hatch, Chairman
The Honorable Senator Wyden, Ranking Member
Senate Committee on Finance
Attn. Editorial and Document Section
Rm. SD-219
Dirksen Senate Office Bldg.
Washington, DC 20510-6200
March 10, 2015
Written Statement for the Senate Finance Committee March 10, 2015
``Tax Complexity, Compliance and Administration:
Merits of Simplification in Tax Reform''
Dear Senator Hatch and Senator Wyden,
I appreciate the opportunity to submit a written statement for the
record of the Senate Finance Committee Hearing on March 10, 2015
regarding tax complexity, compliance and administration as they relate
to tax reform.
The Senate Finance Committee is taking important and much needed action
by considering these issues as an integral part of addressing tax
reform during the 114th Congress.
Today's economy is global in nature. New ways of doing business, an
array of new technologies and a more mobile workforce have resulted in
a complex tax system which is difficult to administer and has led to
issues around compliance. Both the IRS and the tax payer would welcome
measures that simplify the tax system.
I write from the perspective of an American citizen living abroad who:
Has resided and worked in Australia since 1973;
Became a dual citizen of the U.S. and Australian in 1995;
Has met my legal obligations by submitting annual income tax
return to both the Internal Revenue Service and the Australian
Tax Office; and
Requires the services of a tax professional to prepare my U.S.
income tax returns due to the complexity of reporting.
My comments are from the perspective of a non-resident citizen, they
focus on the complexity of the tax system as it relates to individual
tax payers and inadequate service provision by the IRS.
Complexity of the Tax System as it Relates to Individual Tax Payers
In recent years preparing and submitting income tax returns has become
much more time consuming and expensive for non-resident citizens.
A significant amount of reading and a high level of understanding of
the system is required before one can understand which forms need to be
submitted, let alone accurately complete them. The number of forms that
must be completed, the duplication of information required and the
complex nature of instructions can easily result in errors on the part
of the individual, thus causing a heavy administrative load for the
IRS.
Some of the information required for completing tax returns is
difficult if not impossible to obtain. For instance in Australia some
retirement fund managers are unable to provide information required for
U.S. tax returns because of the way the funds are structured and
because fund managers are not required to provide the information for
either U.S. or Australian tax reporting purposes.
More and more non-resident citizens require the services of a tax
professional to prepare their returns. It can be difficult for non-
resident citizens to find a good and affordable tax professional. High
costs are also incurred for printing, postage and conversion of funds
to U.S. dollars for payment of any tax owing.
Both taxpayers and the IRS would benefit from a simplified tax system
that reduces the volume of reporting requirements and eliminates
duplication of reporting. They would also benefit from revised forms
and instructions that are easier to understand and use consistent
terminology.
A residency based taxation system would alleviate many issues currently
faced by non-resident citizens.
Inadequate Service Provision by the IRS
When I first came to Australia non-resident citizens were able to seek
assistance and technical advice from an IRS officer at the U.S.
Consulate. This service assisted many U.S. citizens residing in
Australia to understand and comply with reporting requirements. The
service was withdrawn some years ago and it is now much more difficult
to get assistance of a general nature.
When one receives a notice from the IRS advising of errors in their
return they encounter a number of difficulties including:
The notice arrives close to or after the deadline for action.
There is no time to analyze the content of the notice, to seek-
advice or to prepare an amended return, and if money is owing
people find themselves facing penalties for late payment.
It is very difficult to obtain clarification from the IRS about
errors in a tax return or options for addressing them.
Correspondence by post takes weeks. Even if a person
immediately writes to the IRS seeking information they receive
further correspondence from the IRS advising that they owe
interest before their queries have been addressed. It appears
that a number of individuals or departments within the IRS are
dealing with one individual and that they don't communicate
with one another.
Individuals who endeavor to make contact with the IRS by phone
also face difficulty. Different time zones can provide only
small windows of opportunity for discussing issues of concern.
This is exacerbated by long wait periods once a call has been
placed--I was on hold for more than 45 minutes on two occasions
when I contacted the IRS regarding my, 2012 return. Information
and advice provided over the phone are delivered quickly by
people who are very familiar with the tax system and reporting
forms. There seems to be little understanding or appreciation
that the person on the other end of the phone is not so
conversant with the system and needs information to be fully,
clearly and more slowly delivered. As with written,
correspondence there appears to be a breakdown in communication
between the IRS officers who provide information and advice
over the phone and those who send delinquent notices--I was
advised over the phone that a hold would be put on my case
until I had submitted either a payment or an amended return;
however I received a delinquent notice telling me that I owed
more interest.
The current process of communicating with the IRS to resolve issues
makes people feel frustrated, and intimidated. Sometimes they give up
altogether and never submit another tax return.
Both the Individual taxpayer and the IRS would benefit if the IRS were
funded to implement a more customer focused service, including the
following:
An IRS case manager assigned to assist an individual to
effectively and efficiently resolve an issue;
Email and video conference communication options to facilitate
issue resolution and efficiency of service;
IRS officers who were trained in how to communicate clearly with
their clients using both verbal and written communications;
Longer time frames for postal communication with non-resident
citizens in recognition of the time it takes for international
postal movements; and
A more integrated internal IRS system of communications that
reduced the incidence of IRS officers working at cross
purposes.
I look forward to the 114th Congress enacting a simplified taxation
system as well as working with and funding the IRS to develop customer
support mechanisms, including documentation and communication systems
that support taxpayers and facilitate compliance.
Regards,
Martha Henderson
______
Statement of Calvin H. Johnson, University of Texas Law School
When ``Simplification'' is a Trojan Horse for Great Harm
Statement for Hearing of United States Senate Committee on Finance
March 10, 2015 on Tax Complexity, Compliance, and Administration:
The Merits of Simplification in Tax Reform
Congress's tax code is frequently way over the top too complicated.
With hard work, and perhaps a bit of genius, Congress can simplify the
law in a number of areas, even while improving the fairness and
efficiency of tax.
But Watch Out and Beware! Many proposals offered to this committee
under the cover of simplifications are terrible ideas that will
increase the harm that tax will do to the sum of human happiness.
Indeed, in this hearing, the committee is being offered ideas that will
shift tax burden away from those best able to bear tax downward onto
poorer taxpayers!
The Committee needs to ensure that any idea seriously considered as
a simplification either shifts the burden of taxation upward to
taxpayers better able to pay tax or, at least does no more harm.
A. Moral Decision Makers Do Not Shift Tax Burden Downward.
Dollars have different values depending upon who gets them. Uncle
Scrooge McDuck uses his dollars in lieu of water in his swimming-pool
vaults. When he spends beyond the vaults, he buys caviar, truffles and
bon bons. The loss of any one dollar does not hurt his utility much.
For the Little Match Girl, by contrast, a dollar is a matter of life
and death. Take her last dollar and she freezes to death. The richest
man in the world has the same worth in the sight of God as the Little
Match Girl; it is just the richest man has to spread that worth over
$80 billion and the Little Match Girl spreads her worth over one
dollar. Spreading worth over $80 billion does not quite reach an
infinitesimal value for each dollar, but one over 80 billion per dollar
comes close.
We all display the diminishing utility of money by buying
insurance, by aversion to risk, and by saving as a cushion for a rainy
day and for retirement. The prime directive of personal finance is to
spread out consumption of life-time income over your full life because
doing so maximizes value of each dollar, given diminishing utility.\1\
If your income comes in like a roller coaster ride, you need to move
dollars from the high-income years at the top to the years in the
trough. Otherwise, in the trough, you have no money for to pay the
rent, and you will be trying to eat sand. A tax on money in the trough
or a shift of the tax burden from Uncle Scrooge to the Little Match
Girl will increase the harm that tax does to real people.
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\1\ See, e.g., Franco Modigliani, ``The Life-Cycle Hypothesis of
Saving Twenty Years Later,'' in Contemporary Issues in Economics 2
(1975).
Counting dollars without accounting for the diminishing utility of
a dollar in the hands of wealthier taxpayers would imply that if there
was a program that stole all dollars from the population of 250 million
and gave it to one person, but added one new dollar in the process,
then the program would be treated as good, even though the 250 million
losers would starve to death. GDP measures dollars without diminishing
---------------------------------------------------------------------------
utility, which makes it a questionable measure.
This country is also becoming more unequal, as measured by a
confluence of alternative data. There is a wonderful animation of how
wealth has shifted from poor to rich since 1963, prepared by the Urban
Institute using Survey of Consumer Finance data. The moving pictures
are a must see, worth a thousand words, for each frame.\2\ According to
World Top Income Data Base, the top 1 percent of richest U.S. taxpayer
received 9 percent of U.S. total income in 1973, including capital
gains, and now the top 1 percent receives 23 percent of such income,
which means over two and one half times greater concentration of wealth
in the top 1 percent over the last 30 years.\3\ The richest taxpayer do
now pay a larger fraction of total taxes than they did 40 years ago,
because they are in higher tax brackets and better able to pay tax, but
they do not pay 2\1/2\ times their previous share of taxes.\4\ Indeed,
since 1979, according to Congressional Budget Office, the top 1 percent
has had a reduction in all taxes as a percent of income, dropping from
total tax that is 40 percent of income down to total tax that is 30
percent of income.\5\ Even in the short term, inequality is getting
worse. From 2010-2013, according to Federal Reserve data, the average
income of the top 10% increased by 2 percent, but average income
decreased by 5 percent.\6\
---------------------------------------------------------------------------
\2\ http://datatools.urban.org/Features/wealth-inequality-charts/
img/WealthPercentiles.gif.
\3\ http://topincomes.parisschoolofeconomics.eu/#Graphic.
\4\ Republican Staff of the Senate Finance Committee,
Comprehensive Tax Reform for 2015 and Beyond, at 61 (December 2014),
(hereinafter ``Hatch Report''), http://www.finance.senate.gov/newsroom/
ranking/download/?id=41af09bb-e75d-4246-9313-98eb5b9de
7bc at 62-63 (Table 4.3) showing tax share paid by top 1 percent not
quite doubling (180%) between 1980 and 2011).
\5\ Congressional Budget Office, Trends in the Distribution of
Household Income, 1979-2007, at 26, fig. 18, http://www.cbo.gov/sites/
default/files/10-25-HouseholdIncome_0.pdf //www.
\6\ Steven Rattner, The Year in Charts, NY Times December 30, 2014,
http://stevenrattner.com/article/the-year-in-charts/.
The United States also does the least in the group of rich European
and North American countries to improve the distribution of income.\7\
The better performance outside of the United States, however, is
primarily attributable to higher social
safety-net spending elsewhere, because European taxes are not
especially progressive overall.\8\
---------------------------------------------------------------------------
\7\ Steven Rattner, The Year in Charts, NY Times December 30, 2014,
http://stevenrattner.com/article/the-year-in-charts/.
\8\ Hatch Report at 62.
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1. Flat tax.
A flat tax is a tax that imposes the same tax rate on Uncle Scrooge
and the Little Match girl. A flat tax is touted as simpler than a
bracket tax because one rate would apply to all income, no matter what
its utility.\9\ A flat tax, however, would increase the damage that
taxes do because it would increase the tax paid by the Little Match
girl and reduce the tax paid by Uncle Scrooge for any given level of
government.
---------------------------------------------------------------------------
\9\ See, e.g., J.D. Foster, The New Flat Tax: Easy as One, Two,
Three (Dec. 13, 2011) http://www.heritage.org/research/reports/2011/12/
the-new-flat-tax-easy-as-one-two-three.
A bracket system has many different tax rates. It is plausible that
diminishing marginal utility is a continuous function from near
infinite value for the Little Match Girl to near infinitesimal value
for Uncle Scrooge. As people rise in economic income they move from
destitution, to subsistence, to modest comfort, to middle, to
comfortable, to luxurious, and finally to splendiferous bon-bons. To do
the least damage, a perfect bracket system would adjust marginal rates
to the diminishing marginal utility of each layer of available dollars.
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Fewer brackets make it harder for the rates to adjust to utility.
There is no evidence that a system with fewer brackets is more
efficient.\10\ The brackets are built into tax tables or Turbo Tax.
Indeed, fewer brackets can cause more adverse taxpayer reactions to tax
because fewer brackets require bigger jumps in marginal tax rate
between the brackets for the same revenue. With bigger jumps in rates,
it is plausible that a taxpayer will notice the rate bump more often
and will have a greater motivation to alter behavior to avoid a big
jump to a significantly higher bracket. It is the taxpayer reaction to
tax that causes deadweight loss, without giving revenue to the
Treasury.
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\10\ David Altig & Charles T. Carlstrom, The Efficiency and Welfare
Effects of Tax Reform: Are Fewer Tax Brackets Better than More?
(Minneapolis Federal Reserve Board 1992), https://
www.minneapolisfed.org/research/dp/dp78.pdf.
Simplification is being used in the flat tax argument as a Trojan
Horse to reduce the tax rate on Uncle Scrooge. High marginal taxes at
some point do diminish economic activity so much that they reduce the
Treasury's tax yield--that is the famous Laffer curve. If tax rates are
higher than the rate yielding peak revenue, then a reduction in rates
would then be ``optimal'' and would increase the Treasury's yield. Both
the government and highest rate taxpayers would be better off. If the
tax base is solid and tax is unavoidable, however, the optimal,
maximum-revenue rate is quite high--at 73 percent.\11\ Congress can
keep the revenue-maximizing rate high by reducing Uncle Scrooge's
loopholes and ignoring the formal changes without substance that now
allow him to avoid tax. Indeed, the increase in tax on those best able
to bear tax needs to be accomplished entirely by making taxable income
better describe standard of living, and not by raising tax rates at
all. No one wants a 73 percent tax rate, at least in peace time, but
the optimal rate calculations indicate that there is considerable
cushion before we need to worry about tax on Uncle Scrooge being too
high.
---------------------------------------------------------------------------
\11\ Peter Diamond and Emmanuel Saez , The Case for a Progressive
Tax: From Basic Research to Policy Recommendations 24 J. Econ.
Perspectives 165, 171,
https://www.aeaweb.org/articles.php?doi=10.1257/jep.25.4.165.
The reductions in the top tax rate over the last 65 years,
moreover, are not significantly correlated with greater economic growth
and increases in tax rates are not correlated with less growth.\12\ The
downward shift in the distribution of tax without added growth has
increased the harm of tax. A flat tax, that is, constant tax rates, is
a harmful idea, even evil.
---------------------------------------------------------------------------
\12\ Thomas L. Hungerford, ``Taxes and the Economy: An Economic
Analysis of the Top Tax Rates Since 1945 (Updated),'' CRS (Dec. 12,
2012).
---------------------------------------------------------------------------
2. Expensing.
It is sometimes argued that simplicity requires that small business
taxpayers should be allowed to deduct equipment and inventory that they
have not lost and exclude sales on credit from taxable income.\13\
Those proposals will create an uneven playing field in which bad
investments win over better ones solely because of tax. In a neutral
income tax, taxable income identifies the interest-like income from a
business--the internal rate of return from the investment--and taxes
it. Taxable income will identify the internal rate of return only if
adjusted basis describes the investment value that the taxpayer still
has and has not lost. Deductions in an income tax need to be limited to
amounts the taxpayer has lost. Identifying the internal rate of return
with taxable income is the only way to prevent an investment price from
being higher for high bracket buyers who then outbid low bracket
buyers. Identifying the internal rate of return is the only way to
prevent tax shelters when investments are debt-financed. Identifying
internal rate of return is the only way to prevent inferior investments
from winning over better ones, solely because of tax.\14\
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\13\ Experts #3 and #15, Appendix A, Mihir A. Desai, Testimony
before Senate Finance Committee, Hearings on Tax Complexity,
Compliance, and Administration: The Merits of Simplification in Tax
Reform, (hereinafter ``Desai Statement''), http://
www.finance.senate.gov/hearings/hearing/?id=d121784e-5056-a032-52f3-
e7560f44c675.
\14\ Johnson, Measure Tax Expenditures by Internal Rate of Return,
139 Tax Notes 273 (April 15, 2013).
For nontax purposes, the accountants have long concluded that
accounting can reflect income only if amounts not lost are not
deducted. Inventory accounting is well worth the effort even for small
business. The effort of putting together books of accounting will not
reflect income or any kind of economic reality if amounts not lost are
deducted. Simple and stupid accounts are not worth it. Sales on credit
are still sales, moreover, and subsidy for selling on credit has no
justification. The amounts involved at $1 million are well in excess of
trivial amounts that might be ignored in rounding. If businesses are
going to bother to keep track of costs in order to deduct them, they
---------------------------------------------------------------------------
should account for them right.
Allowing costs that are not in fact lost to be deducted as if they
had expired is a subsidy, equivalent to exemption from tax the return
from the investment in the expensed items. That exemption subsidy will
induce investment in inferior projects that cannot meet the general
global cost of capital.
We do not now have a caste system giving an exemption from tax for
people called ``small business'' even when they are appropriately in
high tax brackets. It would be inefficient and inequitable to allow
such expensing.\15\
---------------------------------------------------------------------------
\15\ Johnson, What Is Very Wrong in Obama's Business Tax Reform.
146 Tax Notes 627 (Feb. 2, 2105).
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3. VAT
It is sometimes said that a value added tax (``VAT'') would
simplify taxation.\16\ A VAT is a kind of sales tax on gross receipts,
except that a VAT entails lots of paper work along a chain of
production and supply. The extra paper work improves compliance.
---------------------------------------------------------------------------
\16\ See, e.g. Joel Slemrod, The Simplification Potential of
Alternatives to Income Tax, 66 Tax Notes 1331 (1995) (touting VAT as
simplification but only as replacement for income tax).
VATs necessarily entail complexities. When adopted, the UK VAT had
four categories of goods: normal tax, exempt, zero tax and mixed. For
zero tax goods, taxpayers further along the production chain got credit
even though no tax was paid. The whole system was administered by the
Bureau of Customs and Excises which had a tradition of viewing every
taxpayer as a smuggler.\17\ Even now, the European VATs have large and
growing evasion problems they need to deal with.\18\
---------------------------------------------------------------------------
\17\ William Turnier, Designing an Efficient Value Added Tax, 39
Tax L. Rev. 435 (1984).
\18\ ``2012 Update Report to the Study to Quantify and Analyse the
VAT Gap in the EU-27 Member States,'' European Commission (Sept. 2014).
VATs have no way to exempt the Little Match Girl at the cashier
counter. It is also not all that simple to find the Little Match Girl
by other means to give her a refund of VAT that we really do not want
her to pay. Inevitably VATs get complicated as legislators try to avoid
freezing little girls. For example, most states exempt from sales tax
food for home consumption to help those with lower incomes, but they
tax restaurant food, which affects those with higher incomes.\19\ Thus,
caviar at $2,400 a pound is tax exempt, while a White Castle meal at
$2.99 is taxable. In Texas, tax is due on candy but not on cake. Are
Rice Crispies with marshmallows a starchy cake or a sweet candy?
Popsicles are subject to tax or not depending on whether they are more
or less than 50 percent fruit juice. Texas sales taxes also get
complicated because of exemption for products covered by other taxes,
e.g., natural resources. VATs inevitably become Rube Goldberg machines
with very high elasticities across complicated dividing lines, as the
tax adjusts to inequity of a simple VAT and to other kinds of taxes.
Those lines yields a tax that does a great deal of dead weight
damage.\20\
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\19\ Center on Budget and Policy Priorities, ``Which States Tax the
Sale of Food for Home Consumption in 2009?'' (Nov. 4, 2009).
\20\ Johnson, We Don't Need No Stinkin' VAT, 139 Tax Notes 527
(April 29, 2013).
A VAT in this country, moreover, will not replace the income tax,
but will be imposed on top of the income tax. That means no reduction
in the complexities of the current income tax, nor pressure to improve
it, but instead a whole new complicated tax system in addition to
current complexities. The issues in the administration of a VAT do not
overlap very well with compliance with an income tax, so that an add-on
VAT will require a new set of tax specialists for every business. In
1984, the Treasury estimated it would need another 20,000 IRS employees
to administer a VAT.\21\ That implies that a VAT would also require
another block-long limestone building in Washington DC. An add-on VAT
is necessarily an increase in complexity.
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\21\ Department of Treasury, 3 Tax Reform for Fairness, Simplicity,
and Economic Growth--Value-Added Tax, 111 (1984).
Since add-on VATs are not justified by simplicity, the surviving
``justification'' for an add-on VAT is just to shift the burden of tax
from Uncle Scrooge to the little Match Girl. We can get a progressive
consumption tax, more simply, with a ``cash flow consumption tax.'' A
cash flow consumption tax would use the same tax officers, even the
same Form 1040. All that would be needed to be changed from current law
is a deduction for investment and disallowance of interest
deductions.\22\ The VAT is offered instead of a cash flow consumption
tax because a cash flow consumption tax would not naturally shift tax
from Uncle Scrooge to the Little Match Girl, while VAT would. Beware of
the VAT and the gifts it brings. Simplification is just a cover.
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\22\ The article that made the cash flow consumption tax a
legitimate subject of discussion is William D. Andrews, ``A
Consumption-Type or Cash Flow Personal Income Tax,'' 87 Harv. L. Rev.
1113 (1974).
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4. Net Operating Losses.
Some tax experts presented to the committee have called for repeal
of limitations on net operating losses (``NOLs'') found in section 382
of the Code because they are too complicated.\23\ Section 382 largely
ended trafficking in NOLs that had also gone on for decades. It is a
great success story. A corporation may take NOLs without limitation
with a continuation of the same owners in whose hands the losses arose,
but if new owners acquire a 50 percent change in ownership within 2
years, the section 382 limitations drop allowable use of NOLs. NOLs may
be used after the change in ownership against an amount of income equal
to a conservative interest rate times the value of the corporation. If
the corporation is worthless, the net operating losses end, but if the
corporation has some value, the transferable tax savings from net
operating losses would be about 20 percent of the value of the
corporation.\24\
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\23\ Desai Statement, Appendix A, Experts #1, #4, #11, #13, #20.
\24\ Net operating losses expire after 20 years. At 5%, a twenty
year annuity is worth \3/8\ of present value of a perpetuity.
Deductions at 35% for 20 years would be worth \3/8\ of 35% or about
20%. The calculation depends critically on discount rates, life of the
business, future tax rates and other assumptions.
Section 382 was developed by a kind of crowd sourcing over a long
period of time.\25\ The prestigious American Law Institute and the best
tax minds in America at the time contributed to the basic framework.
Prior to section 382, corporations could buy their way out of tax by
buying net operating losses, sometimes for pennies on the dollar. When
corporations best able to pay tax were buying tax losses at too cheap a
price, and then tax needed to be increased on taxpayers less able to
pay tax. The sale price of naked tax losses, moreover, represented a
subsidy or negative tax to businesses that had failed the test of the
market place, but had NOLs to sell. It is difficult to see a viable
case for subsidy transfer to money losing corporations identified by
their having lost money. It is said by way of condemnation that Wall
Street believes in privatizing all gains and passing all losses to the
government. Unrestricting NOL trafficking was consistent with that
mantra, at least up to the level of the tax rate on losses.
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\25\ Section 382, as amended by TRA 1986, section 621. See George
K. Yin, ``Of Diamonds & Coal: A Retrospective Examination of the Loss
Carryover Provisions,'' 48 NYU Tax Inst. 41-1 (1990), which gives a
description of the development and adoption of section 382.
If simplification is the only goal, then we might even stop
allowing carryover of NOLs in full after a change of ownership.
Acquirers sometimes keep a moribund business on life supports just to
prevent termination of purchased NOLs.\26\ Something other than pure-
motive simplification is going on in the proposals for repeal of the
section 382 limitations. We can debate limitations on NOLs and look at
alternatives, but simplification is not a useful focusing tool.
``Simplification'' hides conclusions reached for other reasons, and
does not illuminate the issues.
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\26\ See section 382(c) cutting off carryforwards of NOLs if the
old business is discontinued.
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5. Straddles and other loss harvesting.
One expert presented to the committee called for repeal of the
straddle provisions of section 1092.\27\ The underlying problem of
straddles is a serious attack on the core of the income tax: In a
realized income tax, investors can realize the loss leg of a set of
options and hide the gain leg, harvesting tax losses indefinitely
without any net economic loss. Beware of special pleading under cover
of the name ``simplification.'' We should, of course, adopt rules even
more effective against harvesting tax losses. They are endemic in a
realized income tax system. But we alas are missing the genius who tell
us how to effectively meet and end tax harvesting with a clean, clear
administrable rule.
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\27\ Desai Statement, Appendix A, Expert #8.
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B. Ten Promising Ideas and Areas for Simplification.
The U.S. Navy manuals for operating a destroyer are ``designed by
geniuses to be applied by idiots.'' \28\ Our tax system needs to be
designed by geniuses if it is to be simple. Tax simplification,
consistent with fairness and efficiency, is very hard work. Nonetheless
there are promising areas that desperately need simplification work,
and promising ideas including the following 10 suggestions. None of the
suggestions shift the tax burden downward. All but the first will help
close the deficit and reduce federal debt. All improve equity and
efficiency.
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\28\ Herman Wouk, Caine Mutiny, http://www.goodreads.com/quotes/
428350-the-navy-is-a-master-plan-designed-by-geniuses-for, (applying
the argument to all the Navy and not just Navy manuals).
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1. Phase out bubbles.
Section 151(d)(3) of Congress's tax code phases out personal
exemptions and section 68 of the Code phases out many personal
deductions. The impact of the phase outs is identical to an increase in
marginal tax rate within a range or ``bubble'' that disappears for
taxpayers with the most income. The bubble is hard to defend on
rational grounds because standard of living and ability to bear tax
goes up not down as income increases. Congress, moreover, when it is
reasonable, understands that more dependents means more mouths to feed
and that exemptions for more dependents just make taxable income better
reflect standard of living. Within phase outs, however, Congress is
punishing larger families, as if more mouths to feed made the household
better able to pay tax (!!?). The phase outs take 18 lines of work
sheet. The same tax could be collected without the 18 lines, just by
adjusting the section 1 top brackets.\29\
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\29\ Johnson Simplification: Replace the Personal Exemptions
Phaseout Bubble, 77 Tax Notes 1403 (December 22, 1997) (part I),
http://www.utexas.edu/law/faculty/calvinjohnson/77tn1403.htm;
Simplification: Replacement of the Section 68 Limitation on Itemized
Deductions, 78 Tax Notes 89 (January 5, 1998) (part II), http://
www.utexas.edu/law/faculty/calvinjohnson/78tn89.htm.
Given the simple alternative, the function of the phase-out tax,
and the apparent historical motive is to hide higher marginal tax rates
from the people. Hiding the rates from the people is inconsistent with
Congress's moral duty under a democracy of loyalty to the people.
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Congress itself can be evil.
2. Repeal Qualified Pension plans.
The tax benefits from qualified pension plans are distributed,
reverse-Robin Hood, to the richest taxpayers least in trouble in
retirement. The benefits become a trickle to the middle class taxpayers
who sometimes are in trouble in retirement and sometimes not. And the
benefits are denied in full to poorer taxpayers who are in deep trouble
in retirement age. If an intelligent mind had designed the benefits as
if they were real money, the benefits could not be distributed by this
pattern, with the most to given where they do the least good. Indeed,
the well-to-do taxpayer who get the benefits generally reduce their
savings because retirement targets are easier to get, so the rules are
even counter-productive as to the top bracket beneficiaries.
The rules for qualification of a retirement fund are complicated
even for specialists. They are explained in four Bloomberg portfolios
with almost 4,000 total footnotes, and not one footnote is unnecessary
to explain Congress's tax code. This is an over-$100-billion-a-year
issue.\30\ The entire briar patch of qualified plans needs to be
repealed.
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\30\ Johnson, Amazing Waste: Tax Subsidies To Qualified Retirement
Plans, 144 Tax Notes 727 (August 11, 2014), http://ssrn.com/
abstract=2485441.
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3. Withholding tax
The face of the law with the most contact with the most people is
the withholding of tax, required with respect to employees, but not
independent contractors. Congress's Tax Code on this most-common issue
for the people is an unforgivable morass. The definition of
``employee'' depends on ``control,'' which makes sense for tort
liability but has nothing to do whether employer or worker should do
the paper work and pay over tax before the final reconciliation with
the tax return. There is a ``safe harbor'' that is even more
complicated than the employee definition that was adopted in the name
of ``avoiding complexity.'' Withholding is avoided by manipulations
that should not work. Tax administration implies that employers should
handle the payment and paperwork for more than trivial payments because
they are better able to handle it. Payments in excess of $2,000 a month
should always be subject to withholding. The unworkable ``control''
test needs to be abandoned.\31\
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\31\ Johnson, Settle Withholding by the Dollars, Not Control, 136
Tax Notes 949 (Aug. 20, 2012), http://papers.ssrn.com/sol3/
papers.cfm?abstract_id=2135057.
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4. Partnership tax.
Partnership tax rules are supposed to be designed for Mom and Pop
partnership but on issue after issue, they are over the top in
complexity to accomplish very bad tax policy. Partners get tax
deductions shifted to them for losses they do not bear, under
regulations that are not comprehensible.\32\ We defer recognition of
gain or loss upon the bargained exchange by which a partnership is
formed, and then load the law down with provisions that take away the
deferral upon sale or distribution of the property or swap for other
property.\33\ The rules are not well enforced. It would be both better
theory and simpler to tax the exchanges by which a partnership acquires
property. The accountants have it right in treating the initial
exchange between arm's length parties as the rock upon which to build
an accounting system and that means we should tax the exchange and
repeal the complicated deferred tax provisions.
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\32\ Johnson, Partnership Allocations From Nickel-on-the-Dollar
Substance, 134 Tax Notes 873 (Feb. 13, 2012), http://papers.ssrn.com/
sol3/papers.cfm?abstract_id=2005780; Johnson, Twice Measured:
Partnership Level Debt and Partner Outside Basis, 135 Tax Notes--
(pending April, 2015).
\33\ Johnson, Recognizing Built-In Gain on Contribution to a
Partnership, 133 Tax Notes 905 (Nov. 14, 2011), http://papers.ssrn.com/
sol3/papers.cfm?abstract_id=1961144.
More generally, we need to have partnerships be subject to
withholding, audit, settlement, litigation and payment of tax at the
partnership level. The IRS does not have the resources to chase down
500 partners, for initial tax, for audit, for settlement, litigation
and payment of delinquencies. Even if there are only two partners,
having the partnership be responsible for tax by withholding, audit,
litigation, settlement and payment would cut the work for all in half.
Congress might well consider partnership tax as the final payment, for
simplicity, or, in the alternative, it might consider tax paid at the
partnership level as a withholding tax and allow individual taxpayers
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to sue for refund under limited circumstances.
Partnership tax law is too complicated, indeed, for the IRS to
audit given its limited resources. Partnership tax law is one of the
most complicated briar patches in the Code, and taxpayers are getting
away with results no court would allow, even fraud, because the IRS
cannot handle them.
5. Tax Planning Costs.
As a matter of theory the costs of tax planning should not be
deducted because the tax reduction achieved by planning is not taxed.
The deduction is a subsidy from the baseline of neutral tax accounting.
Reducing the subsidy given to tax planning will make the world simpler
by reducing tax planning.\34\
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\34\ Johnson, No Deduction for Tax Planning and Controversy Costs,
129 Tax Notes 333 (Oct. 18, 2010), http://ssrn.com/abstract=2070122.
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6. Internet notice.
The registration of tax liens in the county office where the
property is located is way too cumbersome. Notice in the county
registration does not inform creditors and IRS gets behind in getting
out to the county both to add and releasing liens. In the digital age,
an on-line registry would give information to creditors nationally as
less cost. Digital registration of tax liens needs to replace county
office filing.\35\
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\35\ T. Keith Fogg, National Tax Lien Registry, 120 Tax Notes 783
(Aug. 25, 2008), http://papers.ssrn.com/sol3/
papers.cfm?abstract_id=1520727.
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7. Capitalization of prepayments.
Current regulations allows you to deduct prepayments that will last
no more than one year following close of the year. That is terrible in
theory. There is no justification for deducting next year's expenses
this year, and no justifying deductions of amounts that have not been
lost. Determining whether a payment will expire within the following
year also is very hard. Facts about close of the future year are
difficult to ascertain because the facts have not occurred. The
regulations impose a complicated mechanism to try (inaccurately) to see
if a payment will last more than the one year rule based on
expectations. Simple theory, simply applied, would capitalize anything
called a prepayments. You need only ascertain whether the prepayment
had value at the close of the last year.\36\ This is a case in which a
complicated rule is used to identify if something is so de minimis that
it is not worth arguing about, and the complicated rule is six times
more complicated than just the correct capitalization rule.
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\36\ Johnson, Simplification by Repeal of the One-Year Rule for
Prepayments, 124 Tax Notes 809 (August 24, 2009), http://
www.utexas.edu/law/faculty/calvinjohnson/One-Year-Rule.pdf.
We can avoid some messy valuation disputes in the following three
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issues.
8. Deduction of excluded appreciation on gift to charity.
We should allow only a deduction of basis on contribution of
property to charity. Deducting the appreciation is shelter or double
deduction, because the appreciation is both excluded from income and
also deducted. Deduction of basis only avoids taxpayer cheating on
valuation, and complicated appraisal litigation. Taxpayer can sell at
arm's length and give the proceeds, but the tax system and the country
as a whole then avoid the appraisal fights over valuation.\37\
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\37\ Johnson, Ain't Charity: Disallowing Deductions for Kept
Resources, 128 Tax Notes 545 (Aug. 2, 2010), http://www.utexas.edu/law/
faculty/calvinjohnson/aint_charity.pdf.
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9. Retained benefits in Estate and gift tax.
If benefits from property are retained, the measurement date for
estate and gift tax needs to be delayed. This is simple straightforward
way to avoid multi-billion dollar shenanigans, and hard valuation
problems.\38\
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\38\ Joseph Dodge, Retained Interest Transfers under the Estate and
Gift Tax, 133 Tax Notes 235 (Oct 10, 2011), http://papers.ssrn.com/
sol3/papers.cfm?abstract_id=1944327.
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10. Self-imposed valuation discounts. We need to ignore
restrictions that the testators put on the property themselves in
estate tax valuation. These restrictions probably did not reduce value
to heirs in reality, whatever the claim, because testators do not
rationally reduce value by putting on a restriction. If the restriction
did in fact reduce value to heirs, however, the tax law should
discourage waste, as the underlying common law does, by ignoring the
destructive restriction.\39\
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\39\ Johnson & Joseph M. Dodge, Passing Estate Tax Values Through
the Eye of a Needle, 132 Tax Notes 939 (Aug. 29, 2011),
http://www.utexas.edu/law/faculty/calvinjohnson/eye_of_needle.pdf.
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