Simplifying the Tax Code Sounds Great Until you Realize why it is so Complicated

Darren Gershby Darren Gersh, Washington Bureau Chief

Who can argue against simplifying the tax code? Defending the 67,000-plus page code brands one instantly as the ally of faceless bureaucrats and pedantic tax lawyers — someone who doesn’t “get it.” No sane individual would do that.

But let’s stop for a moment and consider why the tax code is so complicated. There are several reasons and any reformer must address them:

1. Income is not easy to define.

For most of us, income comes in the form of a paycheck. But many high-earners have far more options when it comes to getting paid. Herman Cain, for example, says his flat tax is “gross income less all purchases. . . ” That sounds easy, assuming you know what “income” is.

But what happens when an employer offers stock options or trips on the corporate jet for personal use? What about an insurance payment? As Deloitte Tax’s Clint Stretch points out, “An awful lot of the tax code is about figuring out what is income and when. It’s everything from fringe benefits and deferreed compensation to income disquised as loans or services.”

2. Giving out tax breaks is complicated.

Are you in favor of tuition tax credits? Charitable deductions? The mortgage deduction? Child tax credits? The tax code is filled with all kinds of provisions to help taxpayers buy homes, send kids to college and pay medical bills. Defining those tax breaks and insuring they are not abused makes for a complex tax code. It takes the IRS 108 pages just to describe all the “Individual Retirement Arrangements” offered and how they work.

3. Tax shelters make the code more complicated.

Tax lawyers are some very creative people. Sadly, they are using their creativity in a way that is troubling at best. Digging up ways to help people and corporations shelter income through charities and clever accounting maneuvers is an art form. It also costs the U.S. Treasury billions of dollars. When lawmakers try to close a loophole, they make the tax code more “complicated,” but the only taxpayers caught up in that red tape are people and companies trying to end run the system.

4. For most people the tax code is actually very simple

Just over half of all taxpayers claim the standard deduction and that means their tax returns are simple: fill in your W-2 income, claim deductions, file. And almost all of those claiming the standard deduction pay a marginal tax rate of 15%. In effect, it’s a flat tax. (OK, this isn’t really a reason, so much as an observation. If the code is simple for so many, who is simplification aimed at helping?)

5. The tax code is not just about collecting taxes.

Our tax code does many complicated things. It supports social policy through credits for children and the blind. It supports economic activity through tax incentives to buy equipment and conduct research. It also provides incentives to work through the Earned Income Tax Credit. In short, tax policy does a lot, perhaps too much. Add it up and you get increased complexity.

6. Our economy is complicated.

Hotel companies operate the hotel service, but lease the building. Executives are paid with stock options that are difficult to value. Families operate home businesses and buy tax-free state bonds. We live in a complicated economy. There are many benefits to this economic sophistication, but one clear drawback is complexity. It is probably unrealistic to expect our tax code will be simple when our business and family lives are so complex.

Clearly there are many benefits to a simpler tax code. It would be more efficient, easier to comply with and far less costly to administer. But anyone advocating a code clean up should also say how they intend to address the points raised above.

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