The Tax Policy Center We seem to have an awful lot of complexity in the tax code and I think that — I was thinking a little bit about this over the weekend, having done my taxes earlier than Len and having used Turbotax and finding it actually not very complicated at all — it seemed to me that there are a number of different kind of issues here.
There is the complexity in the tax code that comes from just ridiculous bureaucratic inertia and ridiculous legislation that could be fixed easily. I once did an op-ed piece when I worked at the Boston Globe, in which I rewrote the instructions on the form for the Massachusetts Income Tax Form, translating it form bureaucratese to English and it wasn't that hard and it had half as many words as the State Department of Revenue had. Or the issue that there really isn't any reason to have so many different definitions of what a dependent child is in the tax code. It would be relatively simple to standardize that — a point that Paul O'Neill made. But if that were the whole problem, we wouldn't need to have panels for that.
There's another level of complexity, which I think comes from our unwillingness to make some policy choices — that is, it would be easier for me to do my taxes if I weren't allowed to deduct for the contributions I made of old clothes to the school auction and it would be simpler and they ask — you have to go through, even on Turbotax — how do you know that the box of books was worth $50 rather than $60 and all that. And there'd be an easy way to do that — it's just not let me deduct them. That doesn't seem to be popular. I read over the weekend and recommend to all of you Michael Graetz and Ian Shapiro's book on the estate tax. I want to read you one paragraph there where they discuss how it is that in one of the earlier iterations of estate tax repeal or reform rather, we ended up with a provision that exempted small business that was so complicated, nobody could use it.
Tax legislation, you see, is written by a bunch of well-meaning lawyers sitting around a table in the basement of the Longworth Congressional Office Building. These tax lawyers collectively imagine all the ways that accountants or other lawyers might conspire to take advantage of a tax relief provision. One of the drafters might ask, what if someone buys a small business while on his deathbed? Another might ask, what if the heirs sell the business anyways? A third will ask, how can we give this relief to a company that is publicly traded? Why should we benefit people who have plenty of liquid assets to pay the tax? What if somebody simply takes their liquid assets and puts them all into a family corporation? Do we want to give a tax cut to people who are not American citizens? And on and on and on.
In the tax law boiler room, they say, the motto is anything worth doing is worth overdoing. I think that too often the IRS or the state revenue people get blamed for things that policymakers do deliberately, either to stop fraud or to balance competing interests. And finally, there are those aspects of complexity, which are not complex at all. I'm always amused by people who argue that the progressive income tax is somehow complex and it would be simpler to have a flat rate tax. I mean, either you do it on a computer and it figure it out for you or you go to those little tables in the 1040 and you see your income and go across, it's not complex at all to have a graduated income tax. People — I think — who argue that it is, are people who don't like a progressive income tax and use that as an excuse.
So what should we do about all this? Our speakers today are — in the middle — Eric Toder, who specializes in retirement policy and tax policy issues here at the Urban Institute. Eric's a PH.D. in economics and has worked at the Treasury and the Congressional Budget Office. He'll be followed by Nina Olson, who as I mentioned earlier is the national taxpayer advocate and is a lawyer — but we won't hold that against her. And finally, Lorrie Brown — to my right — is the person at the Washington State Department of Revenue research division, which oversees the economic studies they've done. And we've invited her this morning because she's done work on how much does it cost retailers to collect the retail sales tax, which is a particularly important issue when — as we open a tax reform debate — there are some people who argue that we'd be better off with a — some sort of national consumption tax.
I think the thing that I want to mention before I just turn this over to Eric is that there are a lot of people in Washington and outside who bitch about the tax code. There are very few people who make it their life's work to try and make it better and we're fortunate to have three of them with us here today. So each of them will speak for 8-10 minutes and then maybe I'll ask a question or two and then turn it over to you. So Eric, take it away.
ERIC TODER: Thank you very much, David. I, too, spent the weekend working on my tax returns and am not quite finished. Tax compliance is one of those topics like health care. When you start talking about it, everybody has an anecdote or a story to tell about how they've been affected by the system. And I will — instead of giving anecdotes, at least to start out — will start out by presenting some numbers. These numbers come from a multi-year effort that the IRS has undertaken to measure taxpayer compliance costs. I was involved in that effort when I was director of the office of research at IRS. This is a joint project of the office of research and IBM consulting services, which is doing a lot of the work, and major contributions — I want to acknowledge Mary Phillips, who is the contract monitor for IRS, John Guyton of IBM consulting, who has prepared the tables that you have, and also Scott Stilmar of IBM, who worked on those. Of course there are many others who worked on this project over the years.
What this study that I'll be summarizing today talks about is surveys of individual tax returns. There are two kinds of returns based on the division of the IRS — what are called W and I taxpayers, they are people who just have wages and interest, dividends and capital gains — they just basically have earnings from wages and passive investment income. And then SE or self-employed taxpayers, who in addition to those other kinds of income, have income from Schedule C, from a business, from farms, partnerships, and so forth. The work looks at both these kinds of taxpayers, but it looks only at the burdens imposed, the costs of compliance imposed, on them in filing their tax return and in pre-filing activities. It doesn't look at the effects of dealing with audits. Other research that is ongoing is examining small business burdens and also post-filing burdens.
What this study of individuals is doing basically is based on a survey of 15,000 taxpayers, and it's collecting data on the amount of time they spend doing their tax return and on the amount of dollars they spend — not dollars of taxes paid, but dollars paid to preparers — postage, software, that kind of thing. And if you want to get a total cost or a total burden, you can put a dollar value on somebody's time, but that's outside the model. You can just do that. The model estimates attributes that contribute to compliance burdens and puts together an index of complexity and it can be used to simulate the effects of tax law changes or changes in IRS regulations on compliance costs. What these attributes try to do is capture the technology of complying with the tax law — that is what activities do you actually have to perform — record-keeping, form completion, tax planning — in order to get your return done.
So that brief summary being completed, I will just go — these numbers are in your package, but I just want to recite some of them to you. Total burdens estimated for 2002 — and I should say the survey was done in 1999-2000, so the 2002 burdens are mostly derived from the survey, but they're also based on using the equations to impute how changes in the law and changes in the taxpayer population affected burdens between 2000 and 2002. The estimate is individual taxpayers spend 3 ½ billion hours complying with the tax system and $20.8 billion in out-of-pocket outlays. If you value their time at $20 per hour, that adds up to a compliance cost in 2002 of $91 billion with the individual income tax, which is about 11 percent of 2002 tax liability, to put it in perspective. So it's kind of adding on 10 to 11 percent of your costs.
Per taxpayer, probably a more meaningful figure, self-employed taxpayers spent on the average 59 hours and $384. W and I taxpayers spend 15 hours and $76. So the hours spent by, costs spent by the self-employed per taxpayer were roughly four times as high as the W and I. The self-employed are 26 percent of taxpayers, but incur 54 percent of time costs, and 64 percent of outlays.
What about the question of how you prepare your return? A lot of people go to preparers. In fact, 57 percent of people in the sample — probably a good estimate of the population — used paid preparers in 2002. So most people used paid preparers. 27 percent prepare their returns themselves without using software and 16 percent prepare themselves with software. Self-preparers spend the least time and money of all those three groups, software users spend the most time, and paid preparer users spend the most money. Why do software users spend the most time? Well, we can go back and forth on that — we haven't really nailed that down completely. But one reason is they have very complex returns. Paid preparers have the most complex returns, software users a close second, and those who do it themselves have the least complex returns, not surprisingly.
There's a lot of detail in these numbers. I'll just make a few comments on which groups spend more time and money than others. It shouldn't surprise you — people who itemize deductions spend more time than people who don't. People who file Schedule D — that is capital gains — spend more time than people who don't. People who pay estimated taxes spend more time than people who don't, and people who file Form 6251, which is the Alternative Minimum Tax, spend more time than those who don't. Those numbers are in your sheet and I should point out these are overall comparisons, they're not estimates of the cost of eliminating the provision. So AMT filers may be spending more time because they're doing AMT, but they also may be spending more time because they have more complex returns in other respects. There has been some work done on estimating the effects of the AMT. I won't refer to that now.
Some concluding comments — why is the tax law so complicated? These are my comments, not the model's, and they kind of mirror what David said. Some complexity is just simply the price of having a fair, neutral tax system. That is — if you want a tax system that measures income, that's kind of complicated in some circumstances. And particularly, with respect to business returns, having gone through that last weekend in trying to divide my car use between personal and business — or my wife's car use — I can attest that that is pretty complicated. But yet, it would be wrong to deny costs of business and also wrong to allow personal costs to be deductible. Adjustments for family size also create a lot of complexity, and again it arguably is fair.
But there are also many sources of what I might call gratuitous complexity — that is complexity that is not there in order to have a fair system, but it's there because we're using the tax system for a lot of other purposes of social and economic policy, whether in housing, health, education, savings incentives, and on and on, or things like the Alternative Minimum Tax, which represents a kind of divided attitude about preferences. We like to give them, but we don't like them if you use too many of them. And they reflect also the process of compromises and conflicts in legislation, which lead to compromises that make the system messy.
My final point is, I think the failure until recently and even now to incorporate measures of compliance costs in our discussion of tax policy really leads to that aspect of policy getting short-shrift relative to other concerns like revenue or incentives or something of that nature. So that if we did take these measures in more directly and people could see how much different provisions were actually costing the taxpayer, they might be more likely to pay attention.
MR. WESSEL: Thank you, Eric. Nina?
NINA OLSON: Well, if I can just pick up for a second from what Eric was saying about failure to measure compliance costs. The IRS does have, under small business, self-employed operating division, an office of burden reduction that looks at what they call as burden. Now, I have said to them, looking at burden is one tiny little piece. I'm also interested in you looking at the impact on taxpayer rights, a minor concern of mine. I'm being facetious there. And they are very, very narrowly looking at burden. Some of the things that they have proposed have been increasing the dollar limit for having to fill out a Schedule B, reporting your dividends or reporting your interest. And that certainly decreased some burden and they're able to quantify the numbers.
They've also, sort of gotten carried away in my point of view. They're working right now on a proposal about increasing — getting rid of the interim extension form for claiming an individual extension of filing a tax return. Right now, you can get one that goes to August 15th and then if you want an additional one, you have to file a second piece of paper to get one until October 15th. And they're looking at extending the six-month extension for all entities, including partnerships — and we keep pointing out to them that if you do that, partnerships have the same filing year as individuals, and so some individuals will get their Schedule K-1s on the same date that their actual extended income tax is due, and don't you think there is a better way of doing that. They tend to dismiss that as a very small part of the population — you know, the burden isn't that great. And you know, maybe in the big picture, all of those numbers add up. But I, as the national taxpayer advocate, am concerned about that subset of taxpayers who are really harmed. They have — you know, they're going to get it on that day and where do they go to get additional relief.
So sometimes burden as the driver is not the final answer, although to Eric's point, we absolutely need to consider it. And I think about complexity a lot because my job is to work with taxpayers, solving those problems that complexity creates. And I see complexities showing up all throughout the system. From the very day that you are told you're a taxpayer, you have to figure out how to file your taxes.
Friday, a week ago, I spent the entire day in New York, filming a piece for the Lehrer Newshour, which should be playing this week — so there's my little pitch. And I don't know how many minutes is me, but one thing that we ended up doing, which was a lot of fun, was accosting people on the street in New York City with a camera and a mike in hand. Actually, it wasn't me accosting them, it was the reporter Paul Solmon. And asking people, you know — they had just walked out of the IRS walk-in site — and so you know, what was your experience in there, did you get your problems answered, what happened? And we got this gentleman who had formed a limited liability company. And he had walked in to the walk-in site to just find out how he should — what form he should file his income tax return on his limited — and he thought it was a very simple question. But of course the person behind the counter wouldn't give him an answer, said we'll submit the question to the IRS and in 3-5 days, they'll respond to you and tell you what form you need to file. Well he was outraged — I mean, they've got lots of outrage on tape — because he was outraged that the IRS couldn't answer what form he was supposed to file
Well, of course, the answer is not simple. I asked him on tape, are you the sole owner of this limited liability company. Well, he said yes, and so I said, well then I think that you should be filing a Schedule C, because the entity is disregarded if it's a sole owner. But I said, you should check with somebody. And then, as we kept talking, he started talking about his partner. And I said — ah-ha, you have a partner. Oh, so there are two of you that own this. And he said yes. And I said well then I think you should file a partnership return, but you should check with — so I went home that night and sort of got out my trusty little Regs and everything and of course what that ended up saying was that for more than one owner — if you have a limited liability company with more than one owner — you basically make an election and the election is whether you want to be treated as a partnership or as an association taxed as a corporation. But if you don't make the election, from it was like August something 1997, we're going to treat you as a partnership. And I thought, okay, you need to make an election, but if you don't make, okay fine. How do I explain that to that person on the street? No wonder the IRS employee didn't want to answer that question — that's impossible. And the taxpayer simply thinks, I asked a simple question? What form do I use? That's a perfect example of complexity right out of the box.
David talked about not being willing to make hard choices. I used to prepare income tax returns. I did that from 1975 to 2001. And after the 1986 Act, when we moved employee business expenses to miscellaneous itemized deductions, my clients up through 1986 to 2001 — every year — would bring in their miscellaneous itemized deduction and their medical expenses — even though they were never, ever, ever able to deduct them because of the limits. And I would say to them, don't bother keeping track of this information, please. Unless there's some catastrophic medical expense that's happened to you — unless you've had some major employee business expenses, but they would keep track of them. Because to them, it means it goes to their ability to pay. If you're a nurse, and you're paying out of your own paycheck for your nursing shoes, your nursing uniform, you feel that that should be deducted.
And I know this is slightly anarchic, but I really do believe that the tax system has to listen to the taxpayers to some extent, when they're telling you what net income or taxable income means to them. And so, even though, you could on your model say this requires many more hours for the taxpayer to keep track of this data — you know — of what you're paying in employee business expenses, if the taxpayers are telling you, this matters to me — it matters to my sense of fairness that I am not being taxed on my uniform, then we should be putting that on the return. I think that really goes to a sense of fairness in the system.
I'm going to close my little piece by talking about something — some issues — that I raised to the president's tax reform panel. I sort of gave a wish list of considerations that I would like the tax system to think about in terms of simplicity or simplification. One — I would really like a system that has transparency and doesn't entrap taxpayers and the AMT is the poster child for entrapment.
Again, to go back to the Lehrer Newshour, the cameraman — there was part of it that was an interview of me as opposed to the interviewing people on the street, and we were talking about the AMT and how it had gotten me — it had been a gotcha for me one year — and the cameraman after that particular piece, man he started talking about the AMT and what it did to him. You know, I can't go down the street now without people talking to me about the AMT.
Does not entrap taxpayers, for the majority of Americans, can be complied with on a single form and document match. You know, the IRS gets so much information now in the way of third-party reporting, can we look at what other kind of information we can get in the way of third-party reporting, and then reduce the information that the taxpayer really needs to supply us with — for the majority of taxpayers.
Allows most individual and small business taxpayers to fill out their own returns. And those two, the one that I spoke about just before and this one really sort of dovetail. And I'm not — you know, I have to think some more about how we can do this — but as a goal, I think that that's admirable.
Tax administrators can explain — and that's the limited liability company example. You know, if you've ever tried to explain to a taxpayer the difference between dependency exemption, head of household filing status, married filing joint, earned income credits, just you'll watch their eyes glaze over.
Anticipates the largest areas of non-compliance and that's clearly the self-employed cash economy. And we have to think about a system that captures more information or in some way addresses that aspect of the system.
Does not create whole armies of industries. I would really — you know, we've got an industry that generates refund anticipation loans. We've got industries that are just living off of electronic return preparation. I was in a southern city in a large state six months ago, just walking around, and saw a sign that was very interesting that was advertising — get your returns prepared, get your refund fast, and get a massage. (Chuckling.) And I thought, you know, people don't believe me when I say these things, so I'm going to start taking my digital camera.
The last point is that we have a system that provides choice but not too many options. And there — you know, I've talked in my annual report about education provisions and the retirement provisions in our code. You know, we just have too many choices there. Some choice is good, too many just confound taxpayers.
MR. WESSEL: Thank you, I think there were two interesting things there I want to make sure you all didn't miss. The first is that if you're the national taxpayer advocate, accosting people on the street in New York is quite fun. And secondly, Nina has let you in on one of the little known secrets about journalism in Washington in that compared to the best finance lobbies in town, the guys who stand behind the TV cameras are the most effective. Because every big-shot in Washington is on a TV show one time or another and is in the room for a moment with just the cameraman, who almost always has six times as many opinions as the last cab driver you got on the way to the airport. Lorrie?
LORRIE BROWN: Good morning. One of the attractions of retail sales tax is that it is relatively inexpensive to administer. And that's one of the reasons why there's interest in retail sales tax on a national level. It's one of the least expensive taxes for revenue departments to administer on the state level, and consumers simply pay the tax at time of purchase, usually. However, there are some relatively hidden costs. The bulk of compliance costs with retail sales tax are hidden because they're borne by retailers who act as agents for the state in collecting and remitting sales tax.
In 1998, I did a study, which measured all the costs that retailers faced in collecting and remitting sales tax in Washington State. Washington State actually doesn't have an income tax. We have one of the — statewide overall, we have the highest sales tax in the state — there are a few cities that have higher rates, but 6.5 percent statewide and on an average another 2 percent. So we depend very heavily on sales tax, we're very interested in the sales tax. So keep in mind that although my results that I talk about today are for Washington State, they would be similar for other states, and a lot of the conclusions would apply to a national sales tax too.
Well I found that retailers face costs on average of 1.42 percent of sales tax collections. So if you're looking at a retailer with taxable sales of a million dollars a year, the cost of collecting and remitting the state and local sales tax would be over — could be over — $1200 a year. Now, if all retailers face the same cost of collections, the costs wouldn't necessarily be a problem for retailers. They could probably pass it on to their customers, the customers wouldn't even know. But the costs are not equal. Therefore, retailers facing higher costs have a more difficult time passing their costs on to their customers. They have a more difficult time competing with retailers that have low or zero costs associated with collecting retail sales tax.
There are a number of levels in which costs to retailers are not equal. The most basic level is that some retailers, such as remote sellers — some remote cellars — and retailers in non-sales tax states, are not obligated to collect sales tax. But even amongst retailers who collect sales tax, costs can vary dramatically. In my study of retailer cots, I measured costs for different size retailers. I found that small retailers on average have costs almost 7 times larger, in terms of percentage of tax collected, than the costs for larger retailers. 6.47 percent of sales tax collection for small retailers and .97 percent for large — so big difference, just based on size. But even within size categories, there are cost disparities. Retailers that are audited, appeal an audit, or make honest mistakes in collecting sales tax, can face much larger costs, and I'll talk about this a little more in a minute.
Well what are the costs that retailers face? In my study, I wanted to be as comprehensive as possible and measure all the costs. So for purposes of my study, I defined the cost as anything that a retailer would not do but for the collection of sales tax. Some of these costs are obvious and some are less obvious. Obvious costs are things like credit card fees. Credit card fees are paid on the entire value of the sale, including the sales tax. So the retailers pay a fee on the sales tax itself when it's a credit card transaction. Other costs are point-of-sales costs, such as additional cashier time, additional training time, cost of programming point-of-sale equipment for sales tax rate and base changes, additional cost of paperwork associated with sales tax. These are obvious things that are easy to think of.
Some of the not so obvious costs are higher probability of being audited because of the larger tax dollar volume, an increase in reporting frequency again because of the — or possible increase because of the higher tax dollar volume. And remember, sales tax is not a tax that retailers pay directly, they're just collecting it. But it effects how if they're going to be monthly filers or quarterly filers or annual filers. And also, it affects how frequently they get audited. Mistakes and penalties due on incorrectly sales tax — retailers who mistakenly sales tax when it's due are liable to pay it out of pocket.
A negative cost — in other words, a benefit — to retailers is the float on sales tax. They get the time value of that money while it's in their account until it's remitted. And that period of time varies from state to state, but on average the float does not completely compensate for the other cost. I measured it to be about .4 percent of collections versus 1.42 percent in total cost.
Okay, well what type of cost is the largest cost faced by retailers? Well, that differs depending on size. The largest costs for large retailers is the cost of the credit card fees that they pay on the sales tax collections. And actually, the cost of the credit card fees is pretty much the same for small retailers, even a little higher, but for small retailers, the largest cost is the additional cost of filing more frequently — filing those additional returns, because a lot of small retailers would be quarterly filers maybe than annual filers, if not for the sales tax. Now in the handout — you have a handout in your package — and on the last page I list all the costs and I have measurements of all those costs so you might be interested in looking at that. And if you look at that table, you'll note that some of the costs I measured are insignificant, namely, the additional clerk and cashier hours for all sizes of retailers, additional training time. They came out — there's some costs, but it was very small. And then additional and/or more complex point-of-sale equipment, for the medium and large retailers, there is a cost associated with more or more-complex point-of-sale equipment — you know, those fancy cash registers — for small retailers, but not for the large and medium.
I think here I'll just mention a few words about my methodology so you can understand how I came up with these costs, especially these insignificant costs. Studies that were done before my study showed these costs to be fairly significant, but the way I measured them is most of my data came from a survey of Washington retailers, and also survey of Oregon retailers. Oregon retailers served as a control group because Oregon does not have a sales tax. But since we're bordering each other, it's pretty much the same retailers really. And once I hold all their factors constant, size, etc., I looked at their cost of things like training, and cashiers, and found they were almost the same, once everything else is taken into account — for these things.
Well another interesting thing to note if you look at that table is that some of the costs such as the cost of audit appeals in the state are very low on average. And that's because they don't fall equally on all retailers, they're lumpy. They fall on relatively few taxpayers but they fall heavily on those taxpayers, so those costs can be very high, but on average they look very small and that's a little bit misleading.
Well currently 21 states offer some compensation to retailers for collecting sales tax, but in most of these states, the compensation would not cover the costs as I measured them in this study, and they don't completely address the inequities either. Some of them have caps or — you know — sliding in scales of compensation, so that smaller retailers get compensated proportionally more, but it still does not cover the inequities.
Well the study has some implications for decreasing costs. After this study came out, one change that Washington State made was we limited the number of times that local governments could change their tax rates, and we have 360 some odd local jurisdictions, and prior to this study coming out, they could change their rates whenever they wanted to, and retailers were always changing their point-of-sale equipment, programming them for new rates. You know, retailers had a presence all over the state. So this was something that helped them out somewhat. Now they can only do it on one day each quarter, so there's only four times a year that they have rate changes. But the biggest implication for decreasing costs is simplification. Simplification meaning mostly base, simple base, you know, minimal exemptions — the fewer exemptions, the more simple. Minimal exemptions for groups of people. And of course that's not going to decrease cost of training and such, I measured that as being insignificant. But a lot of the other costs it does help, but especially those costs that fall on particular taxpayers, a handful of taxpayers, the costs of making mistakes — the cost of audits and appeals. You can understand how simplification is going to decrease those costs. The simpler the sales tax is, the less those costs are going to be for retailers.
Well you can access my entire report if you're interested at Washington State Department of Revenue's website. It's www.dor.wa.gov and you just go there and on the homepage and in the left hand corner it says statistics and reports. Click there and you'll find it easily.
So let me summarize. Retailers face significant costs of collections — 1.42 percent of collections on average. Costs are unequal across retailers making it difficult for some retailers to pass the cost onto customers and giving them a competitive disadvantage. Many factors contribute to the total cost of collecting sales tax and compensation is available in some states, but in many of those, it is not sufficient to cover the cost, and nor does it dispel the inequities. And finally, simplification of the sales tax would help minimize costs.
MR. WESSEL: Thank you very much. I think the one thing I learned from looking at your table here is that I'm surprised that the credit card companies haven't figured out that they would be the biggest winners if we had a national retail sales tax.
MS. BROWN: Maybe they're hoping you haven't figured it out.
MR. WESSEL: And I suspect that if you circulate this that they will make that part of their agenda. I just want to ask you one sort of - if you, if Washington State raised the sales tax by 2 percentage points —
MS. BROWN: Yes.
MR. WESSEL: Right? Would the costs — any of these costs — go up? The float to the retailer — that would be an advantage to the retailer, that would go up some. But would any of these costs go up some or would — as percentage of dollar — would they all fall?
MS. BROWN: Most of the costs that I measured are fixed and — except for the credit card fees. Credit card fees would go up and of course any time you make a change, that would change things. But that would be a one-time thing. The probability of getting audited, that would increase somewhat, because you're talking about higher dollar volumes. The cost of making mistakes would go up because you don't collect sales tax and it's two percent higher, well that's 2 percent more that you haven't collected and you have to fork over. But a lot of them are fixed cost. You know, there's a fixed cost of filling out the tax returns, etc. And keep in mind, these costs that I measured, we do have about the highest sales tax rates, so in states that have a lower rate, the costs of collections would be higher as a percentage.
MR. WESSEL: Right. Let me ask Nina and Eric one question before I turn it over to the audience. Eric's tables suggest a very small percentage, let's see, about half a billion hours of 3 ½ billion hours is spent by people who file out the relatively 1040A, 1040EZ. But they spend 10 or 12 hours a piece on the return. Should our goal be to make filling out taxes easier for those people, who have simple returns, where as Nina said the IRS could practically have a computer that printed out their return and just sent it to them and asked them to sign it, or is it a higher priority to deal with this guy that Nina describes, who has a limited liability corporation and a partnership, and thinks that the right way to get information about his taxes is to go to a walk-in center in Manhattan. You know, the AMT, the people who are both self-employed and waged, people who have complex — what should be our higher priority — making taxes even easier for people who have simple returns and probably less education and less money to spend on preparation, or to simplify the complexities for people who have complexities because they actually are well-off.
MR. TODER: Well, I'll take a stab at that. I think that the issue with people who have simple returns — and I'm just kind of doing it from personal experience, as I've filled out somebody's return this weekend — is not so much the time in filling out the return, but there actually are a lot of incentives available that they may not be availing themselves of. So — and of course that goes in the opposite direction from reducing time, it maybe needs more of an investment — but actually this person didn't have their record keeping available, so I couldn't claim one incentive that she was entitled to.
MR. WESSEL: The cost of making it simpler might be that these people would pay more in taxes.
MR. TODER: Yeah, yeah.
MR. WESSEL: Nina?
MS. OLSON: I think that — I think I agree with Eric on that piece. I think I would be focusing a lot more on that middle pocket that is increasingly getting impacted by the number of choices that they have to make. Thinking about the education incentives — and again this is personal —
MR. WESSEL: You mean the incentives in saving for college?
MS. OLSON: For saving for college or being in college, for example, and what provisions are available to you. My son is independent but he's gone back to school. And I was preparing his return a couple of weeks ago and trying to figure out what he was eligible for. And that for something that was a very simple return, but that one little piece was enormously complex. And I kept thinking — to Eric's point — I'm missing something, I'm missing something. I kept going — and I was doing it on the computer — and I kept running it through, because you could run it through any number of things to figure out what's the right way. That level of complexity is problematic for that group of taxpayers. I think — well let me just leave it there, there was another thought that I had, but I think I'll bring it up later.
MR. WESSEL: If you guys are standing in the back, there's a number of seats over here and a number of seats over here, and we don't bite so you can even sit in the front row. I could fill up the time with questions, I'm good at that, but I don't want to. So, does anybody have a question? Sir.
Q: (Off mike.)
MR. WESSEL: Sorry, there's a mike coming down.
Q: Oh, thank you. I'm Don Alexander and have a question about Washington State and administering a national federal sales tax at a tax-inclusive rate of 23 percent. Could your organization do that?
MS. BROWN: Could we what?
Q: Could you administer the Washington State's part of a national federal sales tax with a tax-inclusive rate of 23 percent, 30 percent, the way your 6.5 is computed applying to all services, applying to housing, and not having any exemptions or rate differentials.
MS. BROWN: First of all, I should mention — you know — I'm not answering this in the department's opinion. We just administer, I suppose, whether or not we could do that. But I will mention that having two different tax bases, layered one upon the other would be — there would be some real difficulties with that. It would be very difficult for retailers mostly. For the department to administer? Yeah, I'm not going to say we can't administer it. The rate is not going to make it that much more costly to administer — compliance-wise it would make it more costly. The higher the rate is, the less compliance you're going to get. But the two different bases would be very difficult to deal with but mostly for the retailers. Does that answer your question sufficiently?
Q: By how much would compliance drop?
MS. BROWN: How much might?
Q: Compliance drop? And how many people again, if you can speak just personally, but for your department of course, how many additional people would you have to hire to have a reasonable rate of compliance — like 50 percent?
MS. BROWN: I don't think compliance would drop by that much. I can't answer that. We haven't studied what would happen if the tax rate were that high and they don't know how many additional people. You know, we don't have an income tax. I don't think it would be as many more people as it would be, if we had an income tax. So because it still is the same tax that we administer now, so I don't think I can answer your questions satisfactorily.
MR. WESSEL: But let's just — I want to make sure everybody understands what Don is talking about here. Those people who would prefer to replace our income tax with a national retail sales tax — in order to collect the same amount of money, you'd pretty much have to have a 30 percent national sales tax.
(Audio break, tape change.)
Q: (In progress) -- somehow the federal government gains by having all of its outlays subject to tax and then getting the tax back. So one dollar — I guess they have got one dollar -- you get back -- maybe you have gained a dollar, I'm not sure.
MR. WESSEL: There are a lot of reasons to do that or not to do that. But if you're going to ask about the cost of administering, don't you have to look at the numbers? Eric says we spend $91 billion not counting the government, right -- not counting the government on the income tax. So if you're going to make the case against the national retail sales tax and the cost of administering, you have to look it seems to me at whether there are offsetting savings to individuals and the government on the income tax — (inaudible).
MR. TODER: Well, first of all, to clarify, I said 91 billion (dollars) for individuals —
MR. WESSEL: Right.
MR. TODER: That is not filing; it's not business itself.
MR. WESSEL: Another question?
MS. BROWN: Let me just answer one thing.
MR. WESSEL: Sure.
MS. BROWN: On the compliance side most of the non-compliancy — we call it leakage, comes from having different tax bases. You know, we're right on Oregon's border; they don't have a sales tax; a lot of people go there shopping. We have Indian reservations; people by cigarettes there. And if you have a national sales tax that was equal across the nation, you wouldn't have those kinds of compliance problems.
MR. WESSEL: Right. Because if you had a 23 or 30 percent rate, the incentive to pay the tax would be somewhat greater.
Ma'am, do you have the mike?
Q: My name is Amy Matsui (ph). I'm with the National Women's Law Center. I have a question for Nina Olson.
You know, I was at one of the tax — the president's reform panel meetings where they — where you were testifying and they asked you if you had any recommendations for simplifying the EITCs specifically and I was wondering if you had anything that you would be able to share with us about that?
MR. WESSEL: Why don't you just define the EITC to make sure everybody knows what it is.
MS. OLSON: Oh, can I do that? (Laughter.)
MR. WESSEL: (Inaudible, chuckles.)
MS. OLSON: Yeah, the Earned Income Credit is a refundable credit that is provided to low income taxpayers who work; who have earned income and either have up to two children — that is the largest form of the transfer. And there is a small credit for non — working taxpayers who do not have children reside with them. How is that? Okay.
I have really obviously been thinking about this a great deal over a last couple of years. And the tax reform panel has asked me to submit a paper making recommendations to them about how to help simplify the Earned Income Tax Credit. And I think where I'm going on that paper is to pick up some ideas that some people in the room have talked about — a unified credit.
I have been looking a little bit at the United Kingdom credits and I'm playing back and forth with whether you separate out a refundable credit for earned income from — a refundable credit based on family size and can you eliminate ahead of — you know, basically ahead of filing status. Can you incorporate filing status and even dependency exemption and certainly the child credit into those buckets? And I haven't come up with an answer yet. I'm still — talk to me in two weeks and I'll let you know. I mean, that's sort of an artificial deadline. That is really where I'm going.
I will tell you that where I am playing around with the most is the issue of how much pre-qualifying you do on a credit. I had a conversation earlier this morning with someone from your — actually, it was from the Children's Defense Fund on the error rate with the Earned Income Credit compared to other programs. And you can't look at the error rate with these type of benefit-transfer programs alone; you have to look at the cost of administering. And the EITC has a very high error rate when you compare it to food stamps or some of the other programs.
But when you look at the costs of administering food stamps or TANF — Temporary Assistance to Needy Families and then you compare it to the cost of administering the Earned Income Tax Credit, the Earned Income Tax Credit's cost of the administration are very low and the reason is because we don't do that pre-screening that other federal programs require. And that also results in some of the over-claim. And so where do you decide to reach the balance in that?
The other thing that the Earned Income Credit has that nobody else can claim is the participation rates. We have really high participation rates compared to the other programs that provide benefits to low-income persons. Dave Williams at the EITC cites often the GAO's issues that show that for claimants with two or more children, you know, they have a 92 — it's like 92 to 96 percent participation rate. That is unheard of.
So I don't know what to do in order to — you know, you don't want to impact the participation rate, but you don't want the EITC or whatever kind of refundable credit you have to be the perennial post — you know, whipping boy I guess, you know, for anyone who doesn't like this program. I would really like to end that conversation. I don't — you know, that is really one of my goals, is to just try to find some kind of approach to it.
Did that help? It was a way of answering. I have no idea.
MR. WESSEL: Over there. You have got two mikes. You can do it.
Q: Mike Stavrianos with ASR Analytics. I have a question about Congress' role with respect to tax complexity. And you often hear the concern expressed in the tax administration community that tax complexity is created by Congress, by — through the introduction of special provisions in the tax code, through the administration of social policy as in the case of the EITC through the tax code. And I think a very reasonable reaction that the IRS has taken in light of this concern is to attempt to make tax complexity more visible through the production of estimates of taxpayer burden, through annual reports to Congress from the national taxpayer advocate.
And my question is how do you think that information is influencing Congress' recognition of tax complexity and their reaction to tax complexity in ongoing changes to the tax code?
MR. WESSEL: Eric?
MR. TODER: Well, I don't see any evidence that it is at this stage. I mean, obviously people talk about it but there is always a tradeoff between other things you want to do and it seems like it takes a backseat usually. Now, there have been some examples like the enacting of a unified — uniform definition of a qualifying child for different benefits, which — and years ago when I was at treasury, we changed the provisions for capital gains on homes in ways that I think simplified them. So occasionally a simplification provision will go through and so there are individual steps. But I think it is one step forward and three steps backwards because then other parts of the legislation make it a little much more complicated.
MS. OLSON: You know, I think of the complexity that Congress creates and it falls into a couple of buckets or several buckets. One is there is just the complexity creep and the AMT is actually an example of that as well as an example of everything. But, you know, you enact something that addresses a problem back in 1969 and then you sort of ignore it for a while and more and more — because of the way it is designed, it pulls more and more people in and you have designed other components like indexing the personal exemption — the standard deduction for inflation, not indexing the exemption under AMT. You get it going in both directions and people fall into that ever-widening breach and we never fix it; it just creeps up on you.
So I think there is that, but the AMT is also another good example for the addiction to the revenue that that program brings in. So when you go up to the Hill and you talk about who is being hit by it or you talk to, you know, members of Congress who are hit by it, they will tell you it's a terrible thing but getting the political will to do something about that is really going to hurt.
Things like the uniform definition of a qualifying children — I think my office's contribution to that is to put a face on these kinds of complex provisions; to literally say, this is what it does to taxpayers, you know. My current kick with the AMT — and I did this with the reform commission — reform panel was to put the face on the AMT, which was the Brady Bunch. You know, we took the Brady Bunch and said, okay, if he was, you know, an architect back in the '70s, here is what architects — the medium income is for architects today and here is who it would hit.
And my conclusion was that they should have been living together and not married because she would have gotten — if we gave her like a nursing — a teacher's aid salary, she would have gotten a huge GIT so they would have paid something like $2,500 less than if they were together. (Scattered laughter.) So it would have been — and I say, hey, it would have made it a more interesting TV show, too, you know. (Laughter.)
MR.: (Inaudible.)
MS. OLSON: Yeah, that is right. (Laughter.) But, you know, I have been approached by lots of people for lots of different reasons wanting to do something. When I go to people and talk to them about the retirement provisions and the reform of the retirement provisions, they say, you know, we tried to do that two years ago but the teachers want their program, you know, and so-and-so wants their program, and nobody is willing to give up their own little pieces.
So I think it really depends on — to wrap this up — the AMT. I think that AMT is — this is my personal opinion — going to cause the collision path where it is just going to bring in so much revenue and so many taxpayers are having to go through this, and no matter times you use software, the shock of seeing that little line on your income tax return, where you're thinking, what? And then you go back and you realize that there is this whole separate step that it's going through, that that is going to drive some kind of tax reform. And it will be have to be major because it's going to have to deal with the revenue hit that the — you know, doing something about the AMT is going to create.
MR. WESSEL: Well, it seems to me that, first of all, it must be the case that simplicity as a goal in a focus group slogan is very popular, otherwise they wouldn't keep talking about it; that the only simplicity that is easy — and even that isn't easy — is stuff which is cost-free — the qualifying child thing; that there is not much evidence that anybody wants to pay a cost for simplicity. If you told every taxpayer in America, you can have a simpler tax return but you have to pay $25 more each year, I bet you wouldn't get very many takers.
And, fourth, on the AMT thing, I think it may force some tax reform but I'm sure it will force my simplification. I mean, after all, we could fix the whole AMT problem now by just adjusting the rates so we correct the same amount of revenue. Last time I checked, that wasn't on the president's top-ten wish list of things to do.
Gene, over here.
Q: Gene Steuerle. I wonder if any of you could address an issue that has been bouncing around for a long time but it's often put under the guise of a return-free system, but not necessarily for most taxpayers, but, you know, maybe 30 percent, 50 percent, whatever number you might come up with — whether that is possible today to whether we can move more in that direction. And I ask you to interpret it somewhat liberally because I can also think of a return-free system as one where the IRS might send to the taxpayer information that they have and then ask the taxpayer to make adjustments. So it's not quite return-free.
And then the second amendment to that, which is partly under return-free system, but even in the current system, I wonder why there is not more push as we had in the early '80s when we had a revenue shortfall on more 1099 reporting and better 1099 reporting. And I can think of two areas. One, it's not clear to me why we really need to have charitable contributions where there aren't 1099.
A second area would be — with respect to capital gains, it's not clear we couldn't move pretty much to a system where the full amount of capital gains was actually reported as opposed to just the gross sales and demanding that you have to change rules, like you can't have three options under mutual funds and a lot of stuff like that. But I wonder whether, A, those last steps I'm talking about can be — should be undertaken anyway but also whether there is any possibility at all of moving toward a return-free system at least for some taxpayers.
MR. TODER: I want to make sure I understand the second part of your question. That is that if charities already have to fill out forms if you pay more than $250 — somehow let that show up automatically.
Q: Right. And we go beyond that. I mean, it's not clear to me — I didn't realize that this would be controversial. It's not clear to me that we shouldn't have 1099s for all charitable contributions.
MR. TODER: Oh, I see.
Q: I mean, think of a lot of the abuses that you read about in the paper now. If a charity had to file that 1099, I have a feeling they would not be so ready to —
MR. TODER: So then it would be — you could — (inaudible) — and then your point on capital gains is instead of the broker, a mutual fund reporting the gross amount of sales for stuff that has been purchased in the last 10 or 15 years, they are already figuring out how much the capital gain is. They would just report that.
Q: You would have to change the law to do it because for mutual funds, for instance, you have three options on how you can report it. So you have to bury yourself to one option. And for brokers, you have to require individuals to file basis —
MR. WESSEL: I always thought that the mutual fund — taxation of mutual fund sales was actually a very subtle way to encourage more long-term investment among Americans because if you sell any of it once, you realize how complicated it is and you just sort of leave it all there. (Laughter.) Nina, do you want to take that?
MS. OLSON: Sure, as long as somebody else hits back up on this one.
Let me go to the first one. You know, I have two reactions to that. One, I think that a liberally defined return-free system is really attractive for those truly simple returns, and we do have a ton — a technical term — a ton of those simple returns. You know, interest, maybe some dividends, wage earner, maybe — standard deduction may be very minimum, itemized deductions such as mortgage interest, some charitable contributions. And if you implement your second proposal in the charitable, you could literally create that return with all of the documents that you get in.
The one thing about that is what would you do about the Earned Income Tax Credit? And because the population there changes so much each year — one-third in, one-third out, you know, essentially, the fact and circumstances change so you would be a little nervous changing something out when you might be saying to somebody, you can get $4,000 when in fact maybe they are really eligible only for seven or something like that.
The other concern that I have about that — and this just comes from my personal experience of having prepared returns for as long as I did — was that I had a whole cadre of taxpayers who did such simple — who presented such simple income tax returns but they would come to me every single year, and I would say go away; you don't need me. But they wanted the experience of talking to somebody and looking at what their life had financial been once a year.
And I think that the IRS and the government doesn't really give credence to that act, that ritual act — you know, we all joke about preparing our taxes once a year but for many, many individuals, it is the only time that they ever really sit down and look at what happened to them financially over the last year. And maybe — I wouldn't want to lose that in a return-free system because I think that for the broader health of the country — the financial health of the country, that is an important ritual. So I would want to keep that in mind in whatever system I went to.
The 1099 reporting — you know, I mean, your work — the IRS's work, Eric's work has all shown that, you know, you get people in a withholding system, you have got 99 percent compliance. You get people with income being reported -- 96 percent compliance with the income being reported. That shows up on returns. Those are really stunning numbers, and so we keep thinking about how to expand reporting.
And I'm intrigued by that charity — the charitable contribution one now. I think that a lot of churches are not under that $250-reporting requirement because they are not 501(c)(3)s, but I'm not sure about that; I have to go back and look at the law to see where the unique — since that is such a large amount of where our charitable contributions come from and where people are deducting — how you have to bring that in.
And it seems to me you could do the capital gains. You would have to think about all of the self-service-type stuff — the e-trades and things like that to make sure that they are capable of tracking the basis and that basis transports if you close and account and you go to another; you know, there is that rollover type of information that you would also have to track so you don't lose stuff. But that is really intriguing.
MR. WESSEL: Eric, anything else?
MR. TODER: Yeah, on just a couple of things. Those are excellent, excellent questions. I'll start with the second one. I don't pretend to know the practicality of those proposals. I think they certainly should be considered. And I guess in the light of one thing that — the biggest cost in doing your tax return is record keeping and record keeping is not a cost that is eliminated by using software. So anything you could do on the lines of having firms or institutions do the record keeping for individual taxpayers, and I really like the idea of the capital-gains-basis proposal or even the charitable proposal. I think that would be — those are good ideas to consider. Again, I don't — I haven't thought about all of the potential problems.
On a return-free system, I guess the only thing I would add — I agree with Nina that there is something I like about the fact of people actually doing their tax returns and knowing what they are paying to the government. I think there is something healthy about that. I don't think it should be complicated but I think there is something positive from a citizenship point of view.
I think the other thing is as a matter of practicality, we would have to change the tax law a lot to make the — a return-free system feasible. And one thing we would have to think about is whether we want to continue with joint filing or go to a system of individual filing. That would be —
MR. WESSEL: I want to make two reactions. First of all, I'm not sure that the American people at this point have confidence in the IRS computer systems — that they trust it. And we know that the health insurance system is highly automated and I think all of us that have experience with EOBs — explanation benefits that are not correct — but my guess is that the bottom-half of the population gets screwed and the top-half of the population looks at this and says, well, I couldn't possibly have made that much interest on my tax return.
But just to — one point of clarification on what Eric said. I actually — I did my — as I said, I did my taxes on TurboTax, and there is some of that which is now automated. I could go on the web and draw down the — both — because my wife's company and mine use payroll services so I typed in some ID number in the W-2 and it loaded down all of that information. And I also have money at Fidelity and it went and allocated — I don't think I have any capital gains, but it, for instance, did all of the — automatically what was a qualified dividend and what wasn't. So there is a little bit — we're going a little bit in that direction.
MR. TODER: Well, qualified or not shows up I think on the 1099.
MR. WESSEL: Right, but I didn't even have to touch the 1099.
MR. TODER: Right, right.
MR. WESSEL: The information on the 1099 was automatically downloaded into my return, which meant that I didn't have to — and it was fairly sophisticated; it allowed me to designate that it was mine rather than my kid's, even though they are all listed on the same fidelity account.
MS. OLSON: You know, what is interesting is the concern about — we're talking about all of this information accessible to the government. And part of my role in the IRS is also to make sure that 6103 is a real provision and not — you know — that is the confidentiality thing in that it's not just frittered away by all sorts of little exceptions. And I do get concerned when the IRS is really the recipient of so much information and then can sort of use that at its will and also that it is exposed to lots of other government agencies wanting that information. It just worries me about long-term compliance for the system too.
MR. WESSEL: Here and then here.
Q: Len Burman. First a comment. You said you want people to fill out their taxes every year so they actually figure out how much they owe — how much they pay. You know, my guess is a lot of people think, oh, I didn't owe anything; I got $1,000 back — (chuckles). And actually one problem with going to a return-free system is some people will probably object to not getting a tax refund every year — (chuckles).
One of the things that Lorrie raised — and I think it goes beyond national retail sales or a retail sales tax is just this issue that for businesses, the compliance costs are much larger — much larger for small businesses than they do for large ones. And I think one thing I would like the panel to comment on is the extent to which the tax system actually penalizes small business; it actually might be distorting the way business activities take place and if there is anything that could be done about it. That is the harder question.
MR. WESSEL: Do you want to try that, Lorrie?
MS. BROWN: In Washington State, we don't have a personal income tax, we don't have a corporate income tax; we have a strange tax called the business and occupation tax — a gross receipts tax. And that tax is much harder on small businesses because its on gross receipts and not on profits. And, yes, we have found there are just a number of ways as businesses get larger that they can, you know, legally avoid paying taxes. And it's legal; it's not they're doing something bad; you don't blame them, but the bigger you are, you know, generally the more options that you have. And I think that is the way it is with a lot of taxes — our tax, income — I'm not going to comment on income tax — the sales tax. I'll let you guys comment on the income tax.
MR. TODER: All right. I'll try it first. That is a difficult question because I think it cuts both ways. If you look at compliance and issues that small business — there is an awful lot of noncompliance in the small business area so in some sense, small businesses have the advantage over large businesses that have to keep more records and are more organized. On the other hand, if they do try to comply, it's more expensive. So it's kind of a mixed bag.
I think it's just one of the facts of the tax system that the more independent people are, whether they are self-employed or there is both a higher compliance cost and more opportunity for non-compliance in the — the tax system works better with highly organized activities.
MR. WESSEL: So Lorrie, does anybody ever proposed in Washington State that the state should somehow give money to small businesses to offset, say, the cost of the software or something like that?
MS. BROWN: For retail sales tax?
MR. WESSEL: Yes.
MS. BROWN: Yeah and actually, there is a national effort now called the streamline sales tax agreement -- I don't know how many of you are familiar with that -- and this is a national effort that state governments and businesses join together to try to simplify the sales tax across states by making it more consistent. And one of the things that they are looking into is some sort of compensation for retailers, possibly paying them for — and they are looking mostly at making it simpler for multi-state retailers — electronic retailers, remote sellers, trying to compensate them for the software that they would use.
On the state level, we have looked at different ways of compensating but that could be an effective way of doing that. There is currently a national study being done that is based on the study I did for Washington State and that is one of the issues they are looking to.
MS. OLSON: I think that this is a very difficult issue and I think that the very first question that you start with is what are the burdens that small business is complaining of. And I think you have to say some of them deal with employment tax — that they find it very difficult to deal with the employment tax requirements of withholding and reporting and doing the record keeping there. As more and more small businesses are using payroll tax companies to do that, then that becomes easier — at least the reporting side of it.
Small business is often so marginal that when you really drill down to what they are complaining about, they are complaining about the fact that they don't have the cash and they use the float of the withheld taxes and then they get into compliance problems. So you look at employment tax — I don't quite know how to lessen the burden unless you say to small business you don't have to withhold. And I think that underlines their entire tax system so you can't go there.
On the income-tax side, you know, do you think that depreciation is complicated? Well, if you can write off up to $100,000 of your equipment in any year as long as you don't, you know, sell it in the next year or render it obsolete and then have to do over recapture, that is about as easy as you can get; you no longer have to keep these schedules. Sometimes I think that small business has a problem with inventory, that they just don't have the capacity or they are just not interested, or they don't put the work in the system — sort of what you see in the small business in the sales tax arena, so they get slammed or concerned about how they do inventory counting and what really is the cost of goods. There are exemptions for them for cash accounting, there are exemptions for them for, you know, being out of the inventory rules under 263(a) — you know, cap A.
And then the last piece is I'm seeing more and more small business because they are reading The Wall Street Journal about getting into global economy. You know, and these are small businesses. Well, you go into the international realm, and, you know, the rules are really complex and I don't know what we do with that per se.
So I think — I don't take small business complexity as a lump and I think that we really do a disservice in talking about it by not breaking it down because if you don't break it down, you're never going to be able to address it. And right now where I'm trying to pay some attention is the employment tax side because I think that that is a real burden on these people. I don't know what to do about the globalization side. And that is pretty much where I am.
MR. WESSEL: I think the woman here had a question.
Q: I would invite the panelists — pardon?
MR. WESSEL: Identify yourself.
Q: Rachelle Freedman with Children's Defense Fund. I would invite panelists to comment on the potential you see for real outcome and change as a result of the president's tax commission because it seems to me corporations who now pay about 8 percent of the revenue versus 30-some (percent) in the '50s and well-to-do individuals, both of whom have tremendous political clout, have faired quite well the last for or so years and I wonder if there is really motivation to change the system.
My second comment is I get concerned when I hear a movement toward a consumption or sales tax, which tend to be highly, highly regressive. So I would appreciate your comments in terms of potential for outlook and also overall under the present system and under proposed systems an increased regressivity that I see mounting in our tax system.
MR. WESSEL: Eric, do you want to take a stab at that?
MR. TODER: All right, I'll take a stab at that. It's an interesting question. I have no inside information about what the commission is doing so I don't really know where they are going. One thing that is — I mean, this discussion is focusing on complexity and simplification. There are many other goals that people are trying to promote — I should say tax change rather than tax reform so we don't necessarily put it in a good or bad category.
But there certainly is a movement to eliminate the taxation of investment income and that has strong supporters. It can be done in the form of substituting a retail sales tax or a value-added tax, or something else for the current income tax, or it could be done toward — through changes within the income tax — for example, much bigger reliance on IRA-type accounts.
I think that while taking investment out of the income tax would promote some simplification, if you're really interested in simplification, then you really ought to focus on a lot of things that — and a kind of a reform that many people would be willing to buy on to. You really ought to focus on many of the provisions within the income tax, which I refer to as gratuitous complexity, whether it's a multiplicity of savings incentives or the multiplicity of education incentives. And you kind of go down the line all of the different phase-outs for different benefits — the way the child credit is structured — and clean some of that up and that could get a much broader kind of political consensus.
It wouldn't be easy because I think any change involves winners and losers, and somebody is going to lose their special provision but there would be I think a much better chance of getting some progress than if you try to focus on eliminating the income tax or substantially gutting it. So I guess we'll just have to see what happens.
MR. WESSEL: Yeah, I think that just to give you the journalist point of view real quickly. One is I don't think anybody has a clue what happens with this tax reform commission, that this is one of those things that will evolve and there will be stuff put down that will be on the shelf, and if someone decides the time is right politically to push for tax reform — there is the people who say if Social Security succeeds, then it will be easier to do tax reform; there are other people who say that if Social Security fails then they will want to turn to tax reform — whatever — that it's a long-term process. So that is one thing. I wouldn't believe anybody's forecast.
The second is my observation of the political environment is the consensus that we value a progressive income tax of the kind we had, say, the day George Bush took office is waning. The political consensus in Washington — that that is a goal — a tax policy is waning. That is my reading of the political wind at the moment, not of my own preferences or of anybody on the panel.
MS. OLSON: Well, I'm not going to address the issue of the panel. I mean, I have spoken to the people on the panel and I think that they are very serious about their task and they are trying to be open-minded. I actually believe that.
MR. WESSEL: But their task is to give the treasury more than one alternative.
MS. OLSON: Yes.
MR. WESSEL: And not to build a political consensus binding.
MS. OLSON: Yes, oh, absolutely. But I think they are looking at that charge and trying to figure out what they want to do within that charge. And so I think that to underestimate the independence of the panel may be a mistake even from that charge.
But I was looking the other day at the 1913 income 1040 and it's an interesting form. There were things on it that I didn't know when I sat down and looked at it. It's a very basic form. It's not unlike our 1040 today in many respects. You know, it asks for wages, it asks for interest and dividends. With dividends it says you only report dividends from which are — I think there was a deduction for dividends in which you — which had already been taxed, so you dealt with the double taxation — you know, dividends under our current regime, if you think that is what we're doing under our current regime.
Then it talked about rents. I mean, it literally did go down the line. It let you, at that point, deduct wages that had been withheld from and source, so you had the dividend deduction and you had the wage that had withholding deduction. Then you got a standard deduction of $3,000 if you were single or $4,000 if you married, filing joint. And if somebody was doing a quick calculation in their head, what that might be today and we think that is about $50,000. So that was your standard deduction.
And then you were able to deduct other items — other items and that included all personal interest. So from day one — you know, if there were credit cards back then, that interest would have been deductible. Your trade and business expenses — charitable deductions were missing from the 1913 —
MR. WESSEL: In 1913, the income tax was —
MS. OLSON: One percent.
MR. WESSEL: One percent of the people paid it.
MS. OLSON: One percent.
MR. WESSEL: What percent of the people paid it?
MS. OLSON: I don't know what percent of the people paid it, but —
MR. WESSEL: Less than 10 percent then.
MS. OLSON: Well, it had to have been because if your exemption was either 3,000 (dollars) or $4,000 back then and then it went — it was a flat 1 percent up to the first 20 -- 20,000 (dollars) after you did all of your deductions, then you did another 1 percent between 20 (thousand dollars) and 50,000 (dollars), and you just basically added 1 percent on up.
MR. WESSEL: Well, you give me the size of the federal government in 1913 --
MS. OLSON: Yes.
MR. WESSEL: -- and I will give you a very simple tax. (Chuckles.)
MS. OLSON: But what was interesting was that the structure really was very similar to today.
MR. WESSEL: Maybe time for one more. Oh, please.
MS. BROWN: Let me make a comment on regressivity of sales tax. Sales tax is very regressive and I wish I had some numbers with me but we look at household burdens and it's — if you look at the lowest income group compared to the highest, it's multiple times as a percent of income — the sales tax burden. And the broader you make the base, the more regressive it is generally. There is no mechanism really other than exempting something like food to make it less regressive. And there is nothing, you know, like the EITC to help out households that are, you know, less well off.
But what is interesting is I have looked at surveys of people's opinions about taxes and most people think that the sales tax is one of the most fair taxes that there is because they think of it as, you know, it's your discretion whether you pay it or not. You don't have to buy things so you don't have to pay the tax. Well, in fact, people do have to buy things. (Chuckles.) You know, as tax administrators we know that it is very regressive and not fair but that is not the perception.
MR. WESSEL: Well, I think I'm going to thank the panel very much and thank all of you. We only lost three people during the whole thing, which I take as a great compliment to the quality of the panelists, and thank you, Urban Institute, for sponsoring this.
(Applause.)
(END)
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