In the U.S., nine out of ten people either use tax software or a professional preparer to file their taxes. One of the most commonly used IRS forms, the W-9, shows why. The W-9 is a very simple form that individuals and businesses must submit if they are going to be paid by a company for a service or product. As forms go, it’s easy – there are no calculations, just eight blanks. It is only a half page long. (Of course, since this is the IRS, the instructions take up the other half of the page plus five more.)
The trivial form turns complex, though, in the third item. Check out these instructions:
Note: Check the appropriate box in the line above for the tax classification of the single-member owner. Do not check LLC if the LLC is classified as a single-member LLC that is disregarded from the owner unless the owner of the LLC is another LLC that is not disregarded from the owner for U.S. federal tax purposes. Otherwise, a single-member LLC that is disregarded from the owner should check the appropriate box for the tax classification of its owner.
Seriously? Is this something a normal person can interpret?
Taxes are a double source of friction. The first kind is financial. As I describe in my new book Friction, taxing an activity has a drag effect that reduces the amount of that activity. A ten percent tax on tobacco, for example, has been shown to reduce consumption by roughly four percent over time. Oddly, the numbers are about the same for gasoline taxes. Tax something, and you will get less of that thing.
Can you interpret this text on a common tax form? This is why people don't do their own taxes. #FrictionHunter Click To Tweet
The other type of friction taxes create is compliance friction. Filling in tax forms can be confusing, time-consuming, and high effort. Much like waiting in line at the motor vehicle bureau, citizens put up with this friction because non-compliance isn’t an option. To reduce compliance friction, they get help from software or human experts.
Taxes don’t have to create massive compliance friction. Sales taxes, for example, are collected automatically at the time a purchase is made. The merchant has to send the collected taxes to the state, but in most cases this process is largely automated. For the much larger group of customers, there’s no form, no filing, no paperwork at all. Frictionless, at least from a compliance standpoint.
Income taxes are a compliance nightmare by comparison. The IRS Form 1040, the primary form for individual tax filing, is just two pages long but has instructions that run over 100 pages.
Why So Much Complexity?
While one can fault the IRS for the confusing language it sometimes uses, the overall complexity of the system isn’t the agency’s doing. Rather, it driven by legislators who over decades have used the tax code to encourage or discourage various activities, to accommodate special interests, and for other noble or nefarious purposes.
We can even blame the tax preparation industry itself. Earlier this year, ProPublica described the lobbying efforts by Intuit (maker of TurboTax) and H&R Block to prohibit the IRS from offering free, simple electronic filing.
Occasionally, a legislator will talk about measures that would reduce tax complexity and the effort neeed for compliance. Unfortunately, these ideas never get traction because those changes would affect special interests who benefit from the current system. The outlook for reduced friction in U.S. taxes isn’t promising.