[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

                               __________

                           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

                              ----------                              


                        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.*
---------------------------------------------------------------------------
    * 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.
---------------------------------------------------------------------------
    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
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                                                                                                  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
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Addbacks to Adjusted Gross Income:
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    Deduction for IRA contribution                                            X             X                                                                     X
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    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.
---------------------------------------------------------------------------
    \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.

---------------------------------------------------------------------------
    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. 
---------------------------------------------------------------------------
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.
---------------------------------------------------------------------------
    \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\
---------------------------------------------------------------------------
    \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).

---------------------------------------------------------------------------
    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\
---------------------------------------------------------------------------
    \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.
---------------------------------------------------------------------------
    \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.
---------------------------------------------------------------------------
    \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).

---------------------------------------------------------------------------
    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\
---------------------------------------------------------------------------
    \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.
---------------------------------------------------------------------------
    \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.
---------------------------------------------------------------------------
    \26\ See section 382(c) cutting off carryforwards of NOLs if the 
old business is discontinued.

---------------------------------------------------------------------------
    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.
---------------------------------------------------------------------------
    \27\ Desai Statement, Appendix A, Expert #8.

---------------------------------------------------------------------------
    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.
---------------------------------------------------------------------------
    \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).

---------------------------------------------------------------------------
    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\
---------------------------------------------------------------------------
    \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. 
---------------------------------------------------------------------------
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.
---------------------------------------------------------------------------
    \30\ Johnson, Amazing Waste: Tax Subsidies To Qualified Retirement 
Plans, 144 Tax Notes 727 (August 11, 2014), http://ssrn.com/
abstract=2485441.

---------------------------------------------------------------------------
    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\
---------------------------------------------------------------------------
    \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.

---------------------------------------------------------------------------
    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.
---------------------------------------------------------------------------
    \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 
---------------------------------------------------------------------------
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\
---------------------------------------------------------------------------
    \34\ Johnson, No Deduction for Tax Planning and Controversy Costs, 
129 Tax Notes 333 (Oct. 18, 2010), http://ssrn.com/abstract=2070122.

---------------------------------------------------------------------------
    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\
---------------------------------------------------------------------------
    \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.

---------------------------------------------------------------------------
    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.
---------------------------------------------------------------------------
    \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 
---------------------------------------------------------------------------
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\
---------------------------------------------------------------------------
    \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.

---------------------------------------------------------------------------
    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\
---------------------------------------------------------------------------
    \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.
---------------------------------------------------------------------------
    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\
---------------------------------------------------------------------------
    \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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