TaxA tax is a mandatory payment or charge collected by local, state, and national governments from individuals or businesses to cover the costs of general government services, goods, and activities. Day came and went on April 18th with the regular tax filing deadline, and the Internal Revenue Service (IRS)The Internal Revenue Service (IRS) is part of the U.S. Department of the Treasury and is responsible for enforcing and administering federal tax laws, processing tax returns, performing audits, and offering assistance for American taxpayers. is facing difficulties. It struggled to manage a deluge of 282 million calls made in fiscal year 2021, only answering 11 percent, and a backlog of several million returns from 2021 were left to be processed in 2022.
Several factors contributed to the IRS’s difficulties. Some, such as reduced in-person service, were a direct consequence of the COVID-19 pandemic. But others stemmed from the long-term trend of legislators expanding the IRS’s responsibilities as a benefits administration agency while not simultaneously expanding its capacity to handle them. Major COVID-19 relief provisions, such as the part-monthly Child Tax CreditA tax credit is a provision that reduces a taxpayer’s final tax bill, dollar-for-dollar. A tax credit differs from deductions and exemptions, which reduce taxable income, rather than the taxpayer’s tax bill directly. expansion in the American Rescue Plan of 2021 and the Economic Impact Payments of both 2020 and 2021, fell to the IRS to manage, and that proved difficult, as Erin Collins, the IRS’s Taxpayer Advocate, told Congress in her annual report:
Each financial relief program consumed considerable IRS resources to administer, including overall planning, information technology (IT) programming, implementation, public communications, and responding to taxpayers’ questions and account issues. To address these needs, the IRS had to reallocate resources from its core tax administration responsibilities.”
Improving the taxpayer experience could be accomplished with a few changes. The most direct is improvements to the nuts and bolts of tax filing, starting with the IRS’s operations. The solution to the incredibly low call response rate is to hire more employees to handle increased taxpayer demands. Similarly, new investments in information technology to quickly digitize returns submitted on paper, among more general updates and improved fraud detection software, would also help.
But efforts to improve the taxpayer experience should also include structural improvements to the tax code. Process reforms can only go so far when the tax system is so complicated. For an example of a good change, the Tax Cuts and Jobs Act of 2017 reduced compliance costs for individual taxpayers by raising the standard deductionThe standard deduction reduces a taxpayer’s taxable income by a set amount determined by the government. It was nearly doubled for all classes of filers by the 2017 Tax Cuts and Jobs Act as an incentive for taxpayers not to itemize deductions when filing their federal income taxes. and curbing several itemized deductionItemized deductions allow individuals to subtract designated expenses from their taxable income and can be claimed in lieu of the standard deduction. Itemized deductions include those for state and local taxes, charitable contributions, and mortgage interest. An estimated 13.7 percent of filers itemized in 2019, most being high-income taxpayers. s. The changes meant fewer taxpayers had to itemize and track individual expenses.
The Earned Income Tax Credit (EITC)The Earned Income Tax Credit (EITC) is a refundable tax credit targeted at low-income working families. The credit offsets tax liability, the total amount of tax debt owed by an individual, corporation, or other entity to a taxing authority like the Internal Revenue Service (IRS), and can even generate a refund, with earned income credit amounts calculated on the basis of income and number of children. and Child Tax Credit (CTC)The federal child tax credit (CTC) is a partially refundable credit that allows low- and moderate-income families to reduce their tax liability dollar-for-dollar by up to ,000 for each qualifying child. The credit phases out depending on the modified adjusted gross income amounts for single filers or joint filers. are two major tax provisions in need of simplification. On paper, one might assume that the EITC is focused solely on income, and the CTC solely on support for children. But both have income and family-based eligibility rules, as well as many other requirements (at least 20, in the case of the EITC).
The EITC creates headaches for taxpayers and the IRS alike. IRS Commissioner Rettig recently testified to the House Ways and Means CommitteeThe Committee on Ways and Means, more commonly referred to as the House Ways and Means Committee, is one of 29 U.S. House of Representative committees and is the chief tax-writing committee in the U.S. The House Ways and Means Committee has jurisdiction over all bills relating to taxes and other revenue generation, as well as spending programs like Social Security, Medicare, and unemployment insurance, among others. that the error rate in EITC filings is 25 percent. In 2018, $18.4 billion of EITC payments were improper, $1.2 billion of which were recovered in post-refund enforcement activities.
The Government Accountability Office (GAO) has found that the high error payment rates across the major refundable credits is largely driven by their complexity, arguing, “More EITC claimants make income errors than qualifying children errors, but the dollar value of the errors due to noncompliance with qualifying children requirements is larger than the dollar value of the income errors.”
Because the requirements for qualifying children lead to the costliest errors within the EITC, a number of proposals have suggested consolidating child-related tax benefits into one provision and work-related tax benefits into another.
For the EITC that would mean it no longer varies depending on the number of children, removing the most complex, error-causing aspects of the credit, and focusing its incentives entirely on work. And for the CTC, that would mean it no longer depends on earned income, but is entirely a child-related benefit. The GAO has concluded such consolidation could help solve the issue.
But ultimately, it would make the most sense to take certain provisions out of the tax code entirely. Many proposals suggest moving the CTC entirely out of the tax code under the administration of the Social Security Administration. Of course, such a move would entail additional costs and trade-offs for the SSA, but in combination with simplifying and restructuring the EITC, would make it easier for the IRS to focus on its primary mission of collecting revenue for the federal government.
In the Analects of Confucius, when asked what the first thing he would do to improve governance, the famous Chinese philosopher suggested the “Rectification of Names,” roughly summarized by academic Warren Steinkraus as “things in actual fact should be made to accord with the implications attached to them by names.”
In this context, agencies should match their stated purposes. Accordingly, policymakers should stop using the IRS as a vehicle for social policy and keep its attention on revenue collection.