While working on the National Commission on Economic growth and Tax Reform, we both observed firsthand how the internal revenue code and the IRS are crippling our country.
The Commission was besieged with complaints about the capricious way in which the code is enforced. We heard countless stories of ordinary American citizens who have suffered nightmarish IRS investigations. We received a letter from one woman who enclosed a notice from the IRS assessing her a $150 penalty for a one penny underpayment on her taxes. One taxpayer wrote us expressing a sentiment that is common to many Americans: "Why must we feel bullied and intimidated by agencies of our own government?" Why, indeed. To find the answer we need to look beyond the Frankenstein monster of the IRS -- and find out who and what made the monster what it is. The real villain here is not the IRS, but Congress. Congress gave this agency a mission impossible: to enforce and administer an unenforceable and byzantine tax code. Many of the abuses of the IRS are a natural consequence of the labyrinth complexity of the code itself.
When the income tax system was born in 1913, the New York Times published all of the required forms on one page. At that time there were 3,000 employees at the IRS. Today the tax code is lengthier than the Encyclopedia Britannica and consequently there are now are 115,000 IRS employees to interpret and enforce this monstrosity. (See Table.) Incredibly, the IRS now has more employees than the Environmental Protection Agency, the Occupational Safety and Health Administration, the Federal Bureau of Investigation, the Drug Enforcement Agency, the Food and Drug Administration, and the Bureau of Alcohol Tobacco and Firearms--combined.
Income Tax Then and Now
|Income Taxes Paid (Billions 1994 $)||$6.7||$683.4|
|Per capita income taxes (1994 $)||$69||$2,622|
|Individual tax filers||360,000||113,829,000|
|Percent of population filing return||0.5%||45%|
|IRS Budget (Millions 1994 $)||$110||$7,100|
|Pages of federal tax law||14||9,400|
|Pages of IRS forms||4||4,000|
|Top Tax Rate||7%||40%|
|Tax Rate on Median Family||0%||28%|
Source: Cato Institute and Harpers Magazine, April, 1977, p. 22.
Over just the past ten years Congress has nearly doubled the IRS budget. This year the IRS budget rises by another $600 million--or by 11 percent. Despite the revelations at the recent IRS hearings, Congress still seems to be operating under a "don't ask, don't tell" policy regarding the means by which the IRS does its business.
In his wonderful book, For Good and Evil: The Impact of Taxes on the Course of Civilization, historian Charles Adams reminds us that: "From the earliest records of civilization, tax laws have taken away liberty more often than foreign invaders." Anyone who has had to undergo the indignity of a lengthy IRS audit will not find overstatement in those words. Because of the vague and subjective nature of the current tax code, the criminal provisions of the tax code could technically be used to imprison virtually every taxpayer who signs his name to a return.
Today, without a search warrant, the IRS has the right to examine the personal papers and financial documents of American citizens. Without a trial, the IRS has the right to confiscate private property--and these seizures are becoming more and more routine technique for collecting suspected unpaid taxes. Meanwhile, twice in the last five years the IRS has been reprimanded by the Justice Department because hundreds of IRS auditors and clerks were caught illegally snooping through the returns of friends, neighbors, and celebrities.
Clearly the IRS is an agency in crisis. IRS error rates have soared in recent years. A study by tax attorney Daniel Pilla found that the IRS telephone taxpayer "assistance" program provided about 8.5 million Americans the wrong answer to their tax questions. (That the IRS itself often can't decipher the rules, would seem prima facie evidence that it's high time we started all over with our tax laws.) A recent U.S. General Accounting Office report found that in 1990 the IRS issued 16,000 erroneous liens. Audit results, when challenged overcharge taxpayers an average of $2,000 per return. This is all the more remarkable given that tax court is perhaps the only area of American jurisprudence where the burden of proof is on the accused, not the government. "The IRS fails to meet the standards of financial accountability and diligence that it imposes on the citizenry," concludes a harsh 1994 report on the performance of the IRS.
Congress is now designing an IRS reform bill intended to make the agency more taxpayer friendly. While we applaud the effort, we are convinced that Congress is treating symptoms, not the disease. The cancer is not the IRS: it is the tax system itself.
For the past four decades Congress has tried to make the tax code more "taxpayer friendly" 31 times with an astounding 400 additional revisions through public laws. After almost every "reform," the tax system became more unintelligible not less. In fact, the standing joke in Washington is that the big winner from the tax bill passed this Summer was the tax lawyers and accountants. The joke is more sad than funny--because it rings so true. The 1997 tax bill adds some 600 new pages to the Internal Revenue Code.
Emerson once said that "the field cannot well be seen from within the field. Members of Congress need to step outside the cluttered field for a moment and ask themselves: what is the proper function of a tax code in a democratic society? If the role of the tax code is to regulate human behavior, to encourage some forms of industry over others, to punish bad habits, and to redistribute wealth, then they should just keep tinkering. But if they believe -- as they should -- that the purpose of the tax code is to simply raise revenue, then it's clearly time to consider whether the ludicrously complex, expensive, and burdensome tax code is the best vehicle to accomplish such a straightforward task.
We propose that the first test of a rational tax code should be: Can ordinary Americans function under the system -- even if they are not a lawyer or a CPA? Our internal revenue code flunks this test. The Tax Reform Commission found many, many small business owners who told us that they spent more money each year paying accountants and tax lawyers to figure out how much taxes they owed, than they actually paid in taxes. That is the very essence of a mindless and inefficient tax system.
We all want American industry to compete in win in this new global marketplace, but our tax system is a millstone around the necks of our businesses. Mobil Oil Company told Congress a few years ago that it now spends $10 million a year and has the equivalent of 57 full-time workers to figure out taxes. Mobil's 1994 tax forms weigh 76 pounds and reach a height of more than 6 feet. After serving on the Tax Reform Commission and hearing endless horror stories of this type, we were not at all surprised to learn that under the recently enacted Americans with Disabilities Act a number of Americans are now claiming that "fear of filing" income tax returns is a protected disability.
For all of the billions of dollars that we spend each year at the IRS chasing down tax cheats, there is one unwavering truth about our tax system: tax collection still depends fundamentally on the voluntary compliance of millions of honest American workers and businesses. Without voluntary compliance the system breaks down into chaos. The hearings last week suggested that we may be approaching that critical juncture.
The solution is so obvious. Every study on tax enforcement indicates that there are two overriding factors that increase voluntary compliance: First, the taxpaying public must believe the system is fair. Tax fairness does not mean that the rich pay all the taxes, but rather that everyone is playing by the same rules. And second, that the system is simple, so that workers and taxpayers can easily compute what they owe. We are thoroughly convinced that a fair and simple tax code will do more to increase tax collections than doubling the size of the IRS (God forbid!).
Congress needs to stop talking and begin enacting some type of flat tax. The tax could be paid on a postcard return or as a sales tax. But it must have one low tax rate (20 percent or below). No deductions, loopholes or credits (or at least as few as politically possible). Income must be taxed once and only once--thus ending the punitive treatment of savings and investment. And we would add one special request to Congress: please stop this reckless behavior of monkeying around with the tax system year after year.
A flat tax or consumption tax is the best way to tame the IRS. The intrusiveness of the tax collectors is directly proportional to the size of the tax code. With deductions and loopholes virtually eliminated, the scope of audits will be narrowed considerably because there is so much less information that needs to be reported and monitored. It speaks volumes about the virtues of a flat tax system that those who lobby most passionately against it, are H&R Block and tax lawyers.
A few years ago Parade Magazine polled its readers about whether the current income tax system should be entirely scrapped and replaced with a simple flat rate tax. By 50 to 1 margin readers said abolish the tax code. The most intriguing finding of all was that the editors reported that even hundreds of IRS agents responded with a plea to ax the current tax code.
Somehow it's reassuring that the IRS feels as victimized by our incomprehensible internal revenue code as the rest of us do.