by Cameron Smith
This time of year, flowers are blooming, birds are singing and most Americans are indoors putting together their tax returns. In 1789, Benjamin Franklin famously stated that “in this world nothing can be said to be certain, except death and taxes.”
Unfortunately for many Americans, taxes are anything but certain. Yes, they must be paid, but how they are paid is a source of considerable heartburn for households across the nation.
In the 2010 fiscal year, the IRS processed just over 141 million individual income tax returns. At the same time, the IRS issued more than 119 million refunds with an average refund of over $3,000. In total, the Government held more than $358 billion of individual taxpayer money in 2010.
Before taxpayers rejoice at the refunds returning to their bank accounts, they should stop to consider the economic cost of the practice. Every dollar in overpayment held by the IRS is a dollar removed from the U.S. economy and job creation efforts. Consider that the national median household income in 2009 was $49,777. The money sitting on the economic sidelines because of the inefficiency in our tax code could have “funded” over 7.2 million households. Even though that money eventually makes its way back into the economy as refunds are issued, billions and billions of dollars of economic productivity are lost.
The economic inefficiency in the tax code comes in part from the code’s complexity and how taxes are collected. In 1943, Congress passed the Current Tax Payment Act which established the quarterly income tax withholding system that Americans experience today. Rather than suffering through the pain of writing the IRS a large check at the end of the year, most Americans make rough estimates of their tax liability through their payroll departments. The obvious benefit of this system is that it improves the federal government’s ability to collect taxes. The downside is that most Americans have little awareness of how much tax they are actually paying because they essentially estimate their tax liability. Often this estimation fails to include many of the credits, deductions, and other provisions contained in the tax code.
Not only do Americans make educated guesses at how much they owe the IRS, they are also fail to correctly interpret the code itself. This confusion leads to even more headaches in the form of dreaded IRS audits. In fiscal year 2010, the IRS conducted almost 1.6 million examinations, up from less than half that number a decade earlier.
The most recent major simplification of the tax code was the bipartisan Tax Reform Act of 1986. Almost 25 years later, the tax code has bloated into a patchwork of specialized provisions providing little encouragement or clarity to the average American simply trying to pay what he or she owes.
Regrettably, after the tax bill is paid and refunds are issued, the American taxpayer enters yet another uncertain area. Taxpayers are ill-informed about the effectiveness or direction of their tax dollars moving through the federal government.
Even the Department of the Treasury’s Resource Center recognizes the importance of tax clarity:
Government has become a dominant factor in our economy, absorbing significant resources for its purposes and redirecting many more resources through its regulatory policies and through a mixture of taxation and spending programs that remove resources from some areas to transfer those resources to other areas. It is critical, therefore, that citizens have as much information as possible regarding these diverse programs and regarding their aggregate totals so they may decide for themselves whether the government’s activities are appropriate. Taxes, and especially the paying of taxes, yield citizens a personal sense of the total price of those activities.
The federal government created by the American people also works for the American people. Americans slogging through their tax returns recognize the unnecessarily complex burden placed upon them and the subsequent drain on the economy. The challenge before them now is to decide whether that complexity and drain is necessary or justified by the way the federal government uses the resources it collects.
Most Americans know that we can do better funding our nation, and we must. The beauty of the American democracy is that the will of the people can reform something even as “certain” as taxes.
Cameron Smith is General Counsel and Legislative Liaison for the Alabama Policy Institute, a non-partisan, non-profit research and education organization dedicated to the preservation of free markets, limited government and strong families, which are indispensable to a prosperous society.