Analysis: Nothing New in Presidential Panel’s Tax Reform Report

After reading the long-awaited report of the President’s Advisory Panel on Federal Tax Reform, released November 1, I must conclude the disappointing truth is the report doesn’t tell us anything we didn’t already know.

Here are the panel’s key findings:

• the U.S. federal tax laws are being used for social engineering rather than to raise revenue. This creates much confusion in the law and is the source of most of the instability;

• the use of tax laws for social purposes is the chief culprit behind most of the compliance costs and leads to the inefficient use of resources;

• the profound complexity of the tax code leads to the perception that the tax laws are unfair;

• the lack of transparency in the code means people and businesses don’t know what they’re paying, whether they’ve complied with all their obligations, and whether their neighbors and business competitors have met their obligations;

• the tax system is unstable and unpredictable. Since the Tax Reform Act of 1986, there have been 14,000 changes to the tax law. With this kind of legislative turmoil, businesses and families cannot adequately plan their affairs. This hinders growth and leads to increased compliance costs.

• the unpredictability of the tax code distorts economic decisions that must be made on a routine basis by families and businesses. This causes inefficient allocation of resources and hinders economic growth; and

• the idea of tax simplification is almost always sacrificed to other interests, especially those grounded in social engineering. A sound tax code has to balance the objectives of simplicity, fairness, and promotion of economic growth.

Other Reports Available

We didn’t need a presidentially anointed blue ribbon panel to tell us this.

We could have read the report of the first presidential commission to study this issue. I was a consultant to that commission, chaired by former Congressman Jack Kemp. The National Commission on Economic Growth and Tax Reform (the so-called Kemp Commission) did virtually the same research as Bush’s panel and reached largely the same conclusions in its January 1996 report.

Or we could read the report of the House Ways and Means Committee, “Replacing the Federal Income Tax,” published in response to hearings held before the Kemp Commission on June 6, 7, and 8, 1996. In just three days the Ways and Means Committee, under the direction of Chairman William Archer (R), accomplished what it took the Bush panel nine months to do. I provided testimony to that committee.

Yet another alternative is to read the report produced in 1998 by the General Accounting Office (now known as the Government Accountability Office), titled, “Potential Impact of Alternative Taxes on Taxpayers and Administrators.”

The final and perhaps best alternative would have been to consult the work product of the Institute for Policy Innovation’s “Road Map to Tax Reform Project.” Seventeen reports were produced by 14 economists and tax policy advocates in 2001 and 2002. Not only did that project identify the key problems with the tax system, it also laid out a comprehensive plan for revamping the code. I was a member of the editorial board of that project and contributed a report to the pool of literature that was produced.

Avoids True Flat Tax

The Bush panel came up with two ideas for reform. Those suggestions, if adopted, would take us in the direction of a flat tax system. Plan A is known as the Simplified Income Tax Plan. It is based upon the current tax code with several modifications. Plan B is known as the Growth and Investment Tax Plan. It might be called a somewhat revamped system.

Plan A has all the major characteristics of a flat tax system, but without the single most important element of a flat tax: a single rate under which everybody is taxed. Thus, Plan A effectively eliminates most deductions but does not adequately compensate for the loss by reducing taxes to a single, low rate. That is not unlike what began as part of the Tax Reform Act of 1986.

Plan B gets us closer to the target of a flat tax, because it has fewer rates. However, the proposal still contains multiple tax rates rather than one low rate. On the other hand, Plan B does treat all investment income in the same manner, taxing it all at one low rate of 15 percent.

Tinkering Ahead

While there certainly are some desirable aspects to the panel’s proposals as they relate to businesses, I imagine we’ll continue to see Congress picking away at various aspects of the current code, tinkering and tweaking the law for mostly the wrong reasons. It will make fundamental changes only when it’s forced to.

It will be forced to only when the current system becomes unenforceable. After all, Prohibition was not repealed because highbrow policy analysts showed Congress the error of its ways through hundreds of pages of charts and graphs produced after months of intensive study. Prohibition was repealed because it became unenforceable.

Our income tax system is going in the same direction. The IRS reports the number of tax return non-filers grew at about twice the rate of new tax return filers from 1994 through 2002. More people are behind on their taxes than ever before.

At the same time, the IRS is growing in terms of manpower and money. Its 2006 budget will be nearly $11 billion, and the agency now employs more than 107,000 people. Of its total budget, about $4.7 billion is earmarked for law enforcement activities. By comparison, just 10 years ago the agency’s entire budget was about equal to what it is now spending to enforce the law.

Boosting Enforcement Staff

In addition to the overall growth in manpower and money, the IRS is moving a larger proportion of its personnel into law enforcement roles and out of administrative, processing, and taxpayer assistance roles. Slightly more than 50 percent of the IRS’s employees are currently involved in some type of enforcement activity. Within two years, the IRS expects to move another 10,000 existing workers into enforcement roles, not to mention the number of new hires that go straight into the collection functions.

In order for the IRS to enforce the tax code to the extent it wishes and to the extent Congress demands, the agency would have to have a tax collector on every corner. Not only is that not feasible, it’s unlikely the public would tolerate it.

Only when this reality sinks in will Congress make wholesale changes to the tax code.

Dan Pilla ([email protected]) is a nationally known tax litigation consultant and author of 11 books on IRS abuse prevention and cure, and problem-resolution issues. His latest book is The IRS Problem Solver (HarperCollins). His Web site is http://www.taxhelponline.com.