The Trouble with the Tax Code Is the Tax Code

By Kevin D. Williamson

Wednesday, April 28, 2021

 

If you are reading this, President Biden, I’d like to make a bet with you: If the IRS does get that $80 billion bump in its enforcement budget you’re asking for, I’ll wager that the agency still won’t manage to collect that $700 billion in illegally dodged taxes you promise it will. The main change would be a much nicer charcuterie tray at the next IRS senior-staff retreat.

 

But even if the IRS hits that number, it won’t amount to much — which is a truly weird thing to write about $700 billion.

 

In one sense, spending $80 billion to collect $700 billion worth of taxes due looks like a good investment. But as the Wall Street Journal reports, that $700 billion — over a decade — would represent just a 10 percent reduction in the officially estimated “tax gap,” the difference between what the IRS actually collects and what it believes it is legally entitled to collect. Which is to say, Biden’s proposal would mean — at best — a 10 percent improvement in exchange for a funding increase of more than 50 percent. Spending 50 percent more to get 10 percent better performance is fine if you’re building race cars, but not great if you’re running an agency in an already-bloated federal government.

 

If we take IRS commissioner Charles Rettig at his word — and you should never take an IRS commissioner at his word — then the actual tax gap is far larger than the most recent official estimate: some $1 trillion a year, or $10 trillion over a decade. (I asked the IRS to tell me how that figure was arrived at, and the agency has so far declined to comment. I’ll let you know if they enlighten me.) Clawing back a mere $700 billion out of $10 trillion in taxes owed would amount to, according to my English-major math, bupkis.

 

But there may be even less low-hanging enforcement fruit than you’d think.

 

Contrary to much of what you read in the press, the United States is marked by relatively high levels of voluntary compliance with the tax code. Unlike some of our European cousins — lookin’ at you, Spiros and Giovanni — we Americans are not irrepressible tax cheats. Much of the tax-avoidance bewailed in prolier-than-thou New York Times columns is completely legal tax avoidance, the result of individual and corporate strategies that wring the maximum savings out of our complex and sometimes ambiguous tax code. You may not like that such strategies are legal, but they are legal, which means that we are not going to get rid of them by increasing the enforcement budget, since in these cases there are by definition no legal violations and hence no cause for enforcement as such.

 

It is likely that the most common kind of illegal tax evasion is of the petty, apple-stealing variety: You will not be shocked to learn that America’s bartenders and waitresses and cash-only lawn-care professionals do not reliably report 100 percent of their income to Uncle Stupid, while there are a great many small-time landlords whose rental properties somehow manage never to turn a profit and any number of self-employed people and small-business owners who sometimes stretch for a deduction.

 

But President Biden is interested in none of these — he wants stricter enforcement applied only to people or businesses earning $1 million a year or more. Why? Because it is bad politics for him to take equality under the law seriously and go after low-income tax cheats in the same way he intends to go after high-income crooks. But 1 million waitresses cheating the government out of $1,000 in taxes is, as a matter of revenue — and this is supposed to be about revenue, right? — the same as ten shady businessmen each cheating the government out of $100 million in taxes: $1 billion is $1 billion is $1 billion, however you slice the pie.

 

Of course we should fund the IRS at whatever level is necessary for it to do the work we give it, and it inevitably will prioritize high-dollar cases because the revenue-to-work ratio is more attractive. But maybe we are just giving the IRS too much work. The IRS should enforce the law, but if the tax code were simpler, then it would be less difficult and less expensive to enforce, voluntary compliance probably would be higher, and there would be fewer opportunities for shenanigans of the barely legal variety.

 

We might — but probably won’t — improve collections by 10 percent with that big bump in funding. But mightn’t we also improve collections by simplifying the tax code? If both tax collectors and taxpayers were subject to a simpler and more straightforward tax code, enforcement would be easier — and we probably would need less of it. For years, conservative reformers have advocated a flatter, simpler code with less favoritism and fewer carve-outs for special interests, and that remains the best approach.

 

One step toward radical simplification would be to get rid of the corporate-income tax entirely. Corporate-tax accounting is ridonkulously complex, and the code is full of sweetheart deals for politically connected firms and industries. But we don’t really need to tax corporate income at the corporate level at all, because the money that businesses take in goes back out the door in generally taxable ways: as wages and dividends that are taxable income for their recipients or as business expenses that are somebody else’s taxable income. Money reinvested into a business raises the business’s value, ultimately producing capital gains that can be taxed.

 

The business of the Internal Revenue Service is revenue. And that is what the tax code should be about — not some half-educated nincompoop’s conception of “social justice.” The best tax code is the one that collects the necessary revenue while inflicting the least economic damage. But even that relatively simple task is beyond the current capabilities of the U.S. government, which cannot manage to collect revenue sufficient to fund its spending even with the invasive and complex code we have.

 

(This would be less of a challenge if the government spent less.)

 

While the United States is a relatively low-tax country by the standards of the developed nations, it is not a radically low-tax country: We’re in the same neighborhood as Japan and Australia, with taxes neither as high as Norway nor as low as Singapore. What is notable about our taxation relative to that of our European counterparts is not that billionaires and businesses sometimes pay relatively light taxes here but that the middle classes generally pay so very little. About half of U.S. households owe no federal income tax at all, while the top 1 percent pays 40 percent of federal income taxes and the top 10 percent pays more than 70 percent.

 

The bottom 50 percent? They pay 3 percent of federal income taxes. You can have your Scandinavian welfare state, or you can have a situation in which half of the country pays almost no federal income tax — you cannot have both. That is where President Biden’s class-war politics runs up against some pretty gnarly math.

 

If there are a great many gazillionaire tax-cheats out there escaping prosecution because the IRS doesn’t have enough pencil sharpeners and battering rams, then, by all means, top up the budget and then go and get ’em. The law is the law, and an orderly society enforces its rules. But the real problem with the U.S. tax code isn’t cheats.

 

The real problem with the U.S. tax code is the U.S. tax code.