Be Thankful I Don’t Take It All

Happy Tax Deadline, America!

I happen to be part of the very small minority that doesn’t really mind the process of preparing and filing my tax return.  I enjoy it in part because I happen to generally enjoy math, organization, and logic puzzles, which are basically the main components of a tax filing.  The bigger driver, however, is that my tax situation is pretty simple.  I’m not self-employed, I don’t have dependents, I don’t trade too actively in my investment accounts, and (for better or worse) I tend not to fall into any of the myriad constituencies that have special benefits and pitfalls hidden in the tax code for them.   The types of itemized deductions I can claim are generally the same from year to year, so it’s pretty easy to keep good records of these expenses as I incur them.  H&R Block and TurboTax both make very good, inexpensive software that saves me the headaches of actual form-filling and calculation.  In all, it’s a pretty undramatic process for me, so I have very little to complain about.

There are absolutely ways I could have lived a more tax-efficient year/life, as I realize in hindsight.  In particular, I probably could have incurred a variety of meaningful, non-deductible expenses under the structure of a business or foundation that could have made use of them.  My goal would have been to fully comply with the law.  That compliance would have cost something: for example, whatever organizational books and records I would need to maintain, and the research I (or an accountant) would need to do in order to be sure my activities were all within bounds.  But if the cost of compliance were more than offset by the tax savings I could have realized, it would have been rational (if unpatriotic?) to take those steps. (In my case, I attributed an extremely high value to my own time and cognitive bandwidth, so I can live with the thought that Uncle Sam might have gotten more out of me than strictly necessary.) 

The fact that I even think about how to conduct my affairs more tax-efficiently is an example of the sort of unproductive complexity that, I think, most people agree with eliminating in the abstract, at least until it threatens to increase their effective tax rate.

In the spirit of the season, I’ll recommend a couple of very good pieces that are only slightly diminished by their points that reinforce my claim that many smart people say Ridiculous Things about taxes. 

I completely agree with the last paragraph of this piece by influential blogger Matt Yglesias, which in my mind points out the Ridiculous Thing in Arthur Laffer’s otherwise excellent op-ed in today’s WSJ.  The Ridiculous Thing he does is attribute the complexity of deriving “taxable income” from a person’s income and expenses to the fact that the tax code is progressive.  The complexity is attributable only to the provisions and loopholes that affect the derivation of taxable income.  A system like the one I proposed yesterday, with flat taxes at progressive marginal rates, and with a definition of income that eliminates the arbitrage between various flavors (e.g., wages, dividends), would be both progressive and non-complex.

Apart from that, I think Laffer’s piece nicely points out a few of the hidden costs of a complex tax code and the types of tax-efficiency games that rational actors play – and may in fact be bound to do so as fiduciaries!

The Ridiculous Thing in Yglesias’ piece, however, is the suggestion to pre-populate tax returns for individuals the IRS thinks are likely to have relatively simple tax situations (i.e., a significant population of lower-earning households).  In my ideal world of a non-complex, progressive tax code, this would work pretty well.  In the status quo, however, this suggestion is both inefficient and unfair to the people it purports to help. 

I doubt the IRS has a good way to predict a priori whether a taxpayer is better off itemizing.  A family’s unreimbursed medical expenditures may be very high in some years, for example, which the IRS wouldn’t know.  Similarly, there are tax credits for child and dependent care expenses that are very meaningful to lower-income households that the IRS wouldn’t know about, either.  Maybe the IRS could write in big letters: “If you have a lot of X, Y, or Z expenses, you should file a tax return yourself and not just send in a check.”  But the point is that the IRS can only err on the side of overcharging these taxpayers; if you believe that people don’t want to be bothered to file their tax returns, this is what will happen.  Otherwise, you end up building an infrastructure to pre-populate tax returns that people will have to double-check themselves anyway.

I used to volunteer as an income tax preparer for low-income families – one of several services, by the way, that make it easier for individuals with simple tax situations to reduce their burden of compliance. (The free versions of H&R Block and TurboTax software are another.)  Inevitably there were clients who decided they would rather take a lower refund than return home to pick up the paperwork they would need to claim the credits they were entitled to.  I’m worried about the prospect of replicating this on a larger scale by creating a default that can only overcharge taxpayers.

Here’s to a non-complex, tax-efficient 2011 for all of us!

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