Prepared Remarks of IRS Commissioner Douglas H. Shulman before Harvard Kennedy School, Cambridge, Massachusetts
Nov. 14, 2011
Thank you for that warm welcome. It’s good to be back at the Kennedy School. Having been a student here, it is a great honor to return as IRS Commissioner and speak with you tonight in the Forum.
When I think of the Internal Revenue Service, I’m reminded of what President Kennedy said in a 1961 Message to Congress, “We have not only obligations to fulfill; we have great opportunities to realize.”
And that’s how I see the IRS and my job today… fulfilling our obligations to the nation and America’s taxpayers…while realizing the great opportunities before us...and keeping us on a sustained arc of development.
As IRS Commissioner, I’m the head of a 100,000 employee financial services institution that processes over $2.5 trillion annually for over 200 million customers.
But we’re not just any financial services institution. We’re unique because we touch almost every adult American as well as tens-of-millions of businesses and non-profit organizations every year. Now, most people who hear the letters I-R-S think enforcement. But, in reality, the majority of Americans file a tax return electronically and receive on average a $3,000 refund and don’t hear from us again. My senior team and I spend a large portion of our time thinking about serving taxpayers better. And taxpayer service is on par with enforcement when it comes to fulfilling our mission.
My philosophy is that everybody at the IRS should try to walk in the taxpayers’ shoes and understand their service needs. Indeed, taxpayers’ views about the competency of their government are often shaped by their interactions with us, such as when they call us to discuss whether they are eligible for a tax credit or call to try to resolve an outstanding tax liability. That’s why we hold ourselves to high standards of efficiency and fairness.
In addition to collecting the revenue to run the government, we play other, often less understood roles in the economy.
For example, we were at the center of the economic recovery efforts undertaken during the economic downturn.
We threw an economic lifeline to struggling individual taxpayers through the Making Work Pay credit and for businesses through the loss carryback provision. When the credit markets were clogged and it seemed no one could get a loan, taxpayers quickly accessed capital by claiming new tax loss carrybacks provided by the economic recovery legislation. And the IRS delivered. In all, about $300 billion – or 40 percent – of the Recovery Act has run through the tax system.
As IRS Commissioner, I’m also at the intersection of where public policy meets reality, or implementation. From this vantage point, I have observations that I hope are useful about where tax policy creates challenges – both for the IRS and for taxpayers.
And I believe that the lessons we learn about tax policy confronting reality have implications in other areas that affect us both in America and across the globe.
Before coming to the IRS, I was Vice Chairman of the Financial Industry Regulatory Authority. And the issue of policy actually working on the ground was a major consideration for us there as well.
Indeed, whether in financial markets regulation, a tax system, or any other public policy venue, I would posit that when people make policy they need to be very focused on how it will be implemented. As Kennedy School students, most of you will have, and many of you already have had, a major influence on public policy. And I believe that one of the greatest impediments to effective implementation is complexity.
And that is what I want to focus on today.
Most taxpayers want simplicity. They want to pay what they owe… understand what tax benefits they are entitled to… and not get tripped up by the system. However, today’s tax code is anything but simple. It is so complex that it makes it hard for taxpayers to plan and make out an annual budget as there can be unpredictable tax bill swings from year to year. One year you might be eligible to claim a tax credit reducing what you owe. But the following year, the tax credit will expire, or there may be a change in your personal situation that will knock you out of the eligibility box.
Let me give you a scenario to demonstrate tax code complexity. Take even a very simple case: a married couple, both of whom work, with children. Reporting the income for these two individuals is fairly straightforward as the burden is on their employers to issue them W-2s showing the amounts of taxable income as well as breakouts of other benefits received.
But then take the most basic tax benefit – that for children – and you quickly realize that it is no simple proposition. Benefits for children include the dependency exemption, the child tax credit – a portion of which is refundable as the additional child tax credit – the Earned Income Tax Credit, the Child and Dependent Care Credit as well as the deduction for dependent care expenses.
Each tax benefit has its own series of requirements – some of which overlap, but many of which do not. Many of the tax benefits are income limited or phased out at different income levels. Certain tax benefits must be coordinated with each other. For example, benefits received through a dependent care flexible spending arrangement through an employer must be coordinated with the amount taken for the Child and Dependent Care Credit.
Then start to layer on other complexities, including standard vs. itemized deductions, medical expenses, education expenses, charitable expenses, local taxes, and for many taxpayers, the Alternative Minimum Tax …the list goes on and on. And it gets even more complex if one of the spouses has some self-employment income and files a Schedule C. You get the point.
My central message this evening is this: Making the tax code less complex is the single most important thing that could be done to improve taxpayer service and boost compliance.
Complexity can lead people to not take advantage of tax benefits, largely credits and deductions, that Congress intended them to have, either because they don’t understand them or are afraid they may be ineligible.
And in my experience, when laws or regulations are complex, it creates opportunities for those who want to game the system. And when people game the system and pay less than they owe, it is the honest American taxpayer who picks up the tab.
But, I don’t believe in less complexity only to demystify the tax code and improve tax administration. I also see one of my jobs as Commissioner as being an advocate for the nation’s taxpayers…providing better service and making their lives easier and less burdensome.
Before I discuss any topic, I like to start with the basics. In this case, “What are taxes?” There’s the famous quote from Oliver Wendell Holmes, Jr.: “Taxes are what we pay for civilized society.” And FDR had this take on taxes: “Taxes, after all, are dues that we pay for the privileges of membership in an organized society.”
There’s certainly a lot of truth to what both said. Taxes provide for essential services such as the national defense or highway infrastructure. Taxes are also necessary for the government to have money to help advance beneficial public goals, such as education, clean water and air, saving for retirement and quality health care for our elderly. Taxes are part and parcel of the fabric of our society.
However, tax code complexity means that the average person is not well informed about the tax system. This is a big deal because for many people paying taxes is their only direct interaction with the federal government on an annual basis. They don’t understand one of the biggest bills that they pay every year… their tax bill. And they don’t understand the benefits they can or do receive through the tax code. If you want people to feel engaged with the democratic process, one could argue that they should understand their annual transaction with their federal government.
Perhaps the most telling indicator of taxpayer confusion over the code’s complexity is that today, 90 percent of individual taxpayers pay for professional tax preparation or tax software to prepare their tax returns.
Indeed, the valuable services and efficiencies provided by the tax preparation industry have in some ways masked the increase in taxpayer burden which can be attributed to this complexity. IRS research estimates that over the past 10 years burden for the typical taxpayer has grown. It increased by about 20 percent and would likely be even more if they had to prepare returns themselves without any aids or tools, such as professional return preparers and software. Moreover, we estimate that in the U.S., individual taxpayers and businesses spend more than seven billion hours each year complying with filing requirements.
I approach tax code complexity from the point of view of making policy work on the ground: meaning that we can actually administer it and individuals can cope with the complexity. Some economists and policy-makers advocate that we should keep the tax code pure, with lower rates and no picking of winners and losers. But that’s a whole other discussion – and one on which I’m sure you all have opinions.
Instead, let me reflect a bit more on complexity. As you all know, the core of our tax system is the income tax, which is based on how much money you made in a year – be it through salary, investment income, net income from running a business, or other sources. When people think of income taxes, they think of paying taxes on these earnings.
But, as we all know, the tax system has become much more than that. Over time, Congress has exercised its perfectly legitimate right to create incentives in the tax code to either encourage or discourage particular behaviors.
A whole set of important laws and societal judgments have been written into the tax code.
And it is understandable why implementation of these incentives is given to the IRS.
The IRS already has an economic transaction with most individuals, businesses and non-profit organizations every year and is now recognized as a highly effective and efficient mechanism for distributing economic benefits. Frankly, there’s not another government delivery system as efficient as the IRS. We have become the go-to agency to convey these benefits to individual and business taxpayers.
Our ability to interact with most Americans quickly and efficiently is not unique to the IRS and the U.S.Indeed, in 2008 when many countries were acting to prevent economic disasters, most turned to the tax system to quickly implement recovery policies. In fact, more than half of the G-20 countries relied on their tax systems to implement economic recovery measures. These include Germany, Australia, France, Brazil, Canada, Indonesia, Korea, the United Kingdom, Japan and Russia.
I believe that targeted tax benefits can certainly be valuable and desirable, such as during the recent economic downturn. But unfortunately, we’ve ended up with a complex set of overlapping incentives that have built up over the years. We have expenditures of every kind and flavor, often leaving the taxpayer confused. The numbers tell the story.
The Joint Committee on Taxation found that between 1980 and 2010, the number of tax expenditures in the code grew from slightly less than 100 to almost 250. And at our last count, there have been 3,000 legislative changes to the tax code since the year 2000.
Let me be clear – I don’t oppose providing economic incentives through the tax code. As students of public policy, you know as well as I do that there are times that demand policy-driven incentives that confer economic and social benefits for things that we want for our children, our economic security, the nation’s prosperity and the like. So, it becomes a question and a challenge for policymakers...and for you…to find ways to meet policy goals in a way that is sustainable over time.
Tonight, I want to offer you a few simple, common-sense observations and considerations on how to deal with some of the difficult problems that we at the IRS face in interacting with taxpayers. And hopefully, these observations have broader applications to the policy and administrative challenges that you, as Kennedy School students, will face in many fields of public service.
First. Seek common or standardized definitions. As I mentioned earlier, a good example of a non-standardized definition is the code’s definition of “qualifying child.” Perhaps nowhere else in the world do the same words have so many definitions than in the U.S. Tax Code. It would make Webster weep.
There are different definitions for various child tax-related benefits, such as the Child Tax Credit, the Child and Dependent Care Tax Credit and the Earned Income Tax Credit. It’s mind numbing and exasperating. For example, a child must be under age 17 to let you claim the Child Tax Credit, but for the dependency exemption must be under age 19 or 24 if the child is a full-time student. And different rules apply for the Child Care Tax Credit. These, and other provisions, also include requirements, such that the child live with you for more than half of the year. They may seem straightforward at first, but are something with which taxpayers and the IRS struggle.
And what is the result of all these conflicting definitions and requirements that are difficult to analyze? Regrettably, eligible taxpayers may not claim the credit and others may erroneously or illegally claim it. It’s also harder for the IRS to administer and causes a number of audits we would not have to perform if the tax code was not so complex.
I think this is a cautionary tale for those listening tonight that has implications outside of the tax realm and whose lessons can be applied broadly. Keep your definitions and requirements simple, in ways that can be understood by your target audience.
Second. Do your best to eliminate multiple approaches and hew to just one. A perfect example is promoting higher education. That is certainly a worthwhile and laudable goal as evidenced by our audience tonight. But the tax code is peppered with different and overlapping credits and deductions often promoting the same policy goal.
Indeed, Senate Finance Committee Chairman Max Baucus stated at a hearing this year on tax incentives that “there are more than 15 provisions to assist with the rising costs of higher education. The sheer number of options, and choosing between them, often overwhelms taxpayers.” I agree.
So many different benefits with one goal in mind often confuse people and drive fear about eligibility. The key to incentives is to make them understandable – and arguably significant enough to drive behavior – so that people actually use them.
The lesson here for future policy makers is to try to pick one tax benefit for any given policy goal. If down the road, you need to make modifications, modify that one benefit or create a new one and eliminate the old one. Don’t create multiple benefits trying to accomplish the same thing.
A good example of how this should be done for individual taxpayers is the American Jobs Act of 2011 that President Obama is urging Congress to pass. That bill proposes an extension and expansion of the current reduction in the payroll tax rate. The approach is preferable to creating an entirely new tax concept from scratch.
Third. Try to resist the temptation to enact short-term provisions that may expire but are then extended. This has an enormous unsettling effect on both clarity and stability. Last year, the Joint Committee on Taxation identified more than 130 tax provisions that were set to expire at the end of 2010, with another 65 due to sunset at the end of 2011.
The most visible example of short-term extension is the Alternative Minimum Tax, or AMT. What has happened is that for each year, Congress has enacted an 11th hour AMT “patch” – a short-term adjustment that generally reflects inflation – to prevent more middle-class taxpayers from being caught up in the AMT’s costly web.
This causes instability and uncertainty among taxpayers who cannot plan and create a budget as they may be hit with an enormous tax bill the following year. It also causes operational challenges for the IRS as it must reprogram its computers for the coming tax filing season.
However, in all fairness, we also have to recognize that budget rules drive some of the complexities. Continued “patches” or temporary provisions are more palatable under the budget rules than true reform. In the case of the AMT, the projected cost of repeal under the budget rules has prevented repeal or permanent indexation. This is a reality check for you as future policy makers.
A perfect example of clearing up uncertainty for business taxpayers regarding expiring provisions is the Research and Experimentation tax credit. Its purpose is to foster innovation and technological development while spurring economic growth and competitiveness. However, for the past 30 years, it has been extended 14 times, many of those retroactively, for periods ranging from six months to five years. Such persistent uncertainty about the future availability of the R&E credit diminishes its incentive effect as taxpayers often do not know if they can depend on the credit when making decisions on future investments in research and development. President Obama has proposed to make the R&E credit permanent, thereby eliminating the year-to-year uncertainty and improving the credit’s effectiveness.
Fourth. It’s desirable to set effective dates far enough ahead to allow implementation to go smoothly and to create a real incentive.
Appropriate lead time helps the IRS to educate the public, set up customer service operations, and put in place the appropriate compliance systems so people don’t game the system.
Last year we actually delayed the opening of tax filing for 6.5 million Americans, from January 14th to February 14th because of late tax law changes. That meant 6.5 million people, including school teachers who wanted to take a deduction for classroom supplies that they paid for themselves, had to wait an extra month to get their refund. In any public policy arena, policymakers should strive to give those implementing a law enough time to do it right.
Fifth, and last, is try to see the big picture. In spite of all the bad mouthing it takes, the tax code contains a lot of sound policy that has benefited and continues to benefit millions of our fellow Americans and our nation as a whole. Certainly, while many taxpayers miss the opportunity to claim a deduction or credit because of complexity, many others are very pleased to have more money in their pockets because of them.
But unfortunately, looking at each credit, deduction, income cap, or restrictive definition one by one leads to what we have now, where complexity grows incrementally with every legislative session. Each incentive makes sense in and of itself. However, if we open the aperture wide to capture their totality, the group photo becomes frightening and overwhelming. The 15,000 plus changes to the tax code since 1986 are anything but elegant…anything but simple…anything but clear to the average taxpayer.
In the end, I think you could posit that a simpler system could better further policy goals by having a more involved and engaged taxpayer base that would take advantage of incentives to which they are entitled and thereby improve their economic position.
Coming full circle to what I said earlier in this speech, making the tax code less complex is the single most important thing that could be done to improve taxpayer service and boost compliance.
True enough, what I have discussed this evening is easier said than done. As a friend said to me when I took this job: The tax code and the IRS are a big deal because we’re talking “real” money.
Changes to the tax code, even for the goal everyone agrees on – simplicity – are hard because inevitably it means more money for some and less for others. And I will leave specifics of any proposals to our nation’s elected leaders.
However, from my vantage point of making policy more workable in reality – in my case for the Agency tasked with making the tax system work and for the nation’s taxpayers – it is important that we not give up on the goals of making the tax code less complex and more workable just because it’s hard…just because many have thrown up their hands in frustration and given up.
Since I am speaking this evening at the Kennedy School, I’ll leave you with a few words about leadership in the public sector. My philosophy is that if you have the opportunity to run a major agency that has an important impact on this nation that you have an obligation to move it forward, to position it for the future. One of my favorite quotes is from Will Rogers who said “Even if you are on the right track, if you are standing still, you will get run over.” So while I tell you that the single most important thing we could do to improve taxpayer service and compliance is to reduce complexity in the tax code, at the IRS we are not waiting for that to happen to improve our running of the tax system. We are innovating around multiple customer service channels, including the web, phones, correspondence and face-to-face. And we are innovating in our enforcement programs, through new treatments for taxpayers, better data analytics, and extensive use of pilots to test new approaches. I believe that we have an obligation to always be looking for ways to improve the services we provide to taxpayers.
In one of his last public appearances, the late President Kennedy spoke of the challenges of the space race. He invoked Frank O’Connor, the Irish writer, who wrote how, as a boy, he and his friends would make their way across the countryside. And when they came to a wall that seemed too high to cross, the President said, “they took off their hats and tossed them over the wall – and then they had no choice but to follow them.”
Our nation needs more leaders who will toss their hats over the wall and follow them. As you go out to make a difference in people’s lives and help tackle some of the big issues facing our nation, I encourage you to do just that. Thank you.