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Breaking the Code

By Editorial
August 22, 2011

With Congress having brokered a last minute deal to raise the debt limit, work can begin in earnest on reforming the United States' dysfunctional tax system when lawmakers return from the Congressional recess.

Business and taxpayer groups have for some time been calling for action to simplify the US tax code. But the task will not be an easy one, and the extent of the job in hand was highlighted by a Treasury Inspector General for Tax Administration report on August 17, which came to the somewhat unsurprising conclusion that Congress's near constant tinkering with the code is posing challenges for the Internal Revenue Service (IRS) in terms of its effective administration and enforcement of tax law.

The trouble is that the IRS is no longer merely a tax collector and enforcer, but has been tasked in recent years with administering a multitude of federal tax credit and social programmes, a notable example being President Obama's flagship health care reforms. It is not surprising then, that the agency comes under frequent criticism from TIGTA and taxpayer groups for its poor performance.

Earlier this month, another TIGTA report suggested that while the IRS generally provides helpful and accurate tax law assistance, it is not coping with the sheer volume of enquires from taxpayers trying to accurately complete their tax returns.

A recent analysis of IRS data by the National Taxpayer Advocate Service showed that taxpayers and businesses spend 6.1bn hours a year complying with tax-filing requirements. Indeed, if tax compliance were an industry, the report notes, it would be one of the largest in the United States, employing more than 3m full-time workers in order to provide the work-hours needed to comply with the law.

The situation isn't helped by a political and legislative system that seems incapable of looking at the bigger picture with regard to taxation, and which tends to pass tax laws piecemeal as 'band aid' to solve short-term problems. And each new tax provision, well-intentioned though it may be, adds yet another layer of complexity on top of the existing spaghetti bowl of tax breaks, credits, deductions, loopholes and withholding requirements, meaning that individuals and businesses must spend yet more time figuring out how much tax they owe, and the IRS must stretch its thinly-spread resources still further. President Obama's recent call for two new tax credits to encourage businesses to hire armed forces veterans is one recent example. Another is an ill-thought-through withholding tax on government contractors, which was immediately delayed by Congress when enacted in 2005, and which will be the subject of an IRS hearing next month.

Expanded information reporting rules are also likely to put additional strain on taxpayers and the IRS alike. One such proposal, which is being contested in the Senate, would extend regulations established in 2002 requiring banks and other financial institutions to report the interest paid on deposits maintained by their US offices with respect to Canadian account holders to all non-resident aliens. This, says the Center for Freedom and Prosperity, will merely serve to undermine US interests instead of promote them. At least Congress woke up to the fact that an even more stringent reporting provision, which would have required US businesses to declare to the IRS all payments made to other companies, and for property, of above USD600 in any one year, was a step too far, and repealed thelaw in April.

This is not to say that there is any lack of awareness of the problem of tax complexity in the US. In fact, the respective tax writing committees of the Senate and House of Representatives regularly stage hearings to explore how the income tax system can be simplified, and the tax burden lowered. This effort has been given extra impetus since the Republicans gained control of the House in January. One recent hearing, for example, focussed on how the US tax code encourages debt over equity financing, and considered the distinctions in treatment between the two in the context of tax reform.

However, talk, as the saying goes, is cheap. Putting tax reform proposals in a form that everyone can agree on, and that will be capable of passing both arms of Congress, is going to be quite difficult. This is because lawmakers are in many cases beholden to one special interest or another, even if there is a broad consensus that the USD1.1trillion in special interest tax breaks, otherwise known as 'tax expenditures', that litter the tax code must be culled.

Even the business community appears split on whether, or how far, Congress should reform the tax system.

On the one hand, the United States Chamber of Commerce (USCC), which represents three million US businesses, says that wholesale reform of both the tax code and entitlement programmes is not only desirable, but necessary in the context of the federal government's debt crisis, putting this view across in a letter to the 12 members of the Joint Select Committee on Deficit Reduction, a new advisory body, as if there weren't enough of them already, formed as part of the window-dressing that went along with the debt limit increase at the beginning of August.

On the other hand, certain industries are very protective of the tax breaks provided for in the code. A report released by the Information Technology and Innovation Foundation (ITIF) goes so far as to warn that a simpler United States corporate tax code could be an anti-competitive, slower-growth tax code. "The tax simplification orthodoxy that pervades Washington's thinking is misguided," says ITIF President Robert D. Atkinson, the report's author. "The record is clear. Tax incentives that increase investment in workers, equipment, IT, and innovation help boost productivity and economic vitality."

It has now been 25 years since the last major reforms took place to the US tax code, and much of that work it seems has been undone. But with the more immediate problem of America's debt hanging over Congress, and with presidential elections looming in 2012, it could be a few more years yet before tax reform becomes more than a pious hope. As St Augustine said: "I will be chaste, but not yet".



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