Sweating the Small Stuff:
The Cost of Immaterial Tax Law Provisions
Stanley Veliotis*
The United States federal income tax law has been the subject of decades of
study due to its burgeoning level of detail and complexity, including many
calls to scrap the income tax and replace it with new approaches, such as a
consumption tax. This Article argues that a more manageable and
pragmatic approach to improving the tax law, itself a creature of
incrementalism, is to reverse its complexity through an incrementalist
approach. The tax code contains many immaterial provisions, including
two provisions applicable to millions of individuals (the $100 floor on
personal casualty and theft deductions, and the up-to-$250 deduction for
educators). Such provisions have trivial budget implications and negligible,
if any, incentive effects on taxpayer behavior. These provisions add
unnecessary complexity and thus inflate transaction costs for the
government and taxpayer. For the immaterial provisions residing within
tax expenditures, such as the educator deduction, an institutional
economics analysis reveals such tax expenditures are ideal candidates for
removal from the tax code, to instead be directly expended by the
government. The Article offers recommendations as to how to identify and
eliminate tax law clutter.
INTRODUCTION
The United States federal income tax law has been the subject of
decades of study as to its progressively increasing level of complexity. 1 Our
current income tax has become a “mess:” not efficient, not simple and not
comprehensible. 2 One can reasonably expect and tolerate extensive
complexity in a tax law provision that wrestles with the substantive tax
*
Assistant Professor of Accounting & Taxation, Fordham University Schools of
Business. I thank Fordham University for funding under its Faculty Fellowship Spring
2011 program. I also thank an anonymous referee for many helpful suggestions.
1
Sheldon D. Pollack, Tax Complexity, Reform, and the Illusions of Tax Simplification,
2 GEO. MASON IND. L. REV. 319, 320 (1994) (“tax simplification has emerged as one of
the perennial themes in the academic tax literature”). See infra note 72 for samples of
articles in recent decades.
2
MICHAEL J. GRAETZ, 100 MILLION UNNECESSARY RETURNS xi, 14 (2008); ROBERT E.
HALL & ALVIN RABUSHKA, THE FLAT TAX 1–2 (2d ed. 1995). See also Maya J. Randall,
IRS Watchdog Seeks Overhaul of Tax Code, WALL ST. J., Apr. 15, 2011, available at
http://online.wsj.com/article/SB10001424052748704495004576264941206503826.html
(citing Nina Olson, National Taxpayer Advocate, testimony to Congress that the tax code
is a mess and in dire need of simplification).
2011]
SWEATING THE SMALL STUFF
37
treatment of a transaction or relationship. 3 The level of detail in these
provisions is necessitated by the complex substance of the analysis,
reflections of a world complicated, for example, by aggressive tax
avoidance and globalization.4 Contrast these necessarily complicated
provisions with tax provisions that address no complicated issue yet contain
tedious, often arbitrary, details, including immaterial 5 floors or ceilings.
These gnats add unnecessary complexity and costs to our tax law.
This Article details two examples of immaterial tax laws: the $100 floor
on personal casualty and theft deductions 6 (“$100 floor”) and the up-to$250 deduction for educators (“educator deduction”).7 Provisions such as
these add another straw to the taxpayer camel’s back by requiring them to
“sweat the small stuff.” 8 The unnecessary and trivial nature of these
requirements evokes Kafka,9 red tape,10 and the dreaded “TPS report” in
3
See examples of this so-called “judgmental complexity” infra notes 123–27 and
accompanying text.
4
Much of tax law complexity is “inevitable because human circumstances and financial
transactions take so many forms.” Michelle Arnopol Cecil, Toward Adding Further
Complexity to the Internal Revenue Code: A New Paradigm for the Deductibility of
Capital Losses, 4 U. ILL. L. REV. 1083, 1086 (1999).
5
The use of the word “immaterial” in this Article is meant to convey its conversational
use: “of no substantial consequence.” Immaterial Definition, MERRIAM-WEBSTER.COM,
http://www.merriam-webster.com/dictionary/immaterial (last visited Dec. 22, 2011). The
term is not meant to convey lack of materiality as used in legal settings, such as whether
false testimony is material (see, e.g., Elizabeth G. Livingston, Judicial Treatment of the
Element of Materiality in Federal Criminal False Statement Statutes, 72 TUL. L. REV.
1343 (1998)), or whether a false representation alleged in, for example, a stock fraud case,
was material. See, e.g., James Park, Assessing the Materiality of Financial Misstatements,
34 J. CORP. L. 513 (2009). However, similar to the focus of this Article, the law does
occasionally present settings in which a determination of whether an error is material
enough to correct is a function of the costs to correct it. As an example, Park points out
that reporting firms may eschew use of Generally Accepted Accounting Principles for
items that are not material. Id. at 524 (“At some threshold, the cost of ensuring that every
transaction complies with GAAP is not worth the marginal benefit to investors”) (citations
and footnote omitted). The Securities and Exchange Commission also considers cost in
various portions of its guidance on materiality. SEC Staff Accounting Bulletin No. 99, 64
Fed. Reg. 45,150, 45,151 (1999), available at http://www.sec.gov/interps/account/sab9
9.htm (e.g., Exchange Act does not require firms to make major expenditures to correct
small misstatements; “[c]onversely, where there is little cost or delay involved in
correcting a misstatement, failing to do so is unlikely to be ‘reasonable’”).
6
I.R.C. § 165(h) (2006).
7
I.R.C. § 62(a)(2)(D) (2006).
8
“Sweating the small stuff” became a popular term after publication of the best-selling
self-help book, RICHARD CARLSON, DON’T SWEAT THE SMALL STUFF AND IT’S ALL SMALL
STUFF (1997). The phrase is often used in economic and legal settings in connection with
situations involving tedious but immaterial details. See, e.g., Elizabeth Williamson, As
U.S. Economic Problems Loom, House, Senate Sweats the Small Stuff; Members of
Congress Love a Good Resolution; Watermelons and Undertakers Fit the Bill, WALL ST.
J., Aug. 19, 2008, at A1.
9
See Parker B. Potter, Jr., Ordeal by Trial: Judicial References to the Nightmare World
of Franz Kafka, 3 PIERCE L. REV. 195 (2005). We can imagine Kafka writing about the
38
WILLIAM & MARY POLICY REVIEW
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the comedy Office Space. 11 This Article argues that the Internal Revenue
Code (“Code”) is replete with many immaterial tax law provisions that
have trivial budget implications and minimal (if any) incentive effects on
taxpayer behavior. They also add significant transaction costs for the
government and taxpayer. This is especially the case for immaterial tax
laws operating as tax expenditures, such as the educator deduction, where
efficiency argues in favor of direct expenditure by government instead of
by millions of individual taxpayers.
The burden of tax rules with immaterial thresholds imposes a hidden
cost that often outweighs the perceived benefit Congress had in mind when
enacting the provision. 12 This helps lead to loss of confidence in our tax
system and drives taxpayers to become even more frustrated with the
annual settlement of their tax account.13 It also often makes the services of
nightmare of thousands of pages of rules, especially a continually changing set of tax
rules. For example, in The Trial, the subject of government persecution, K, finds it
difficult to discern what a painting represents. “‘It is Justice,’ said the painter. . . . ‘Now I
can recognize it,’ said K. ‘There’s the bandages over the eyes, and here are the scales. But
aren’t there wings on the figure’s heels, and isn’t it flying?’ ‘Yes,’ said the painter, ‘my
instructions were to paint it like that; actually it is Justice and the goddess of Victory in
one.’ ‘Not a very good combination, surely,’ said K., smiling. ‘Justice must stand quite
still, or else the scales will waver and a just verdict will become impossible.’ ‘I had to
follow my client’s instructions,’ said the painter.” FRANZ KAFKA, THE TRIAL 182–83
(Willa & Edwin Muir trans., The Modern Library 1956) (1925).
10
The term “red tape,” a shortcut phrase for extensive unnecessary regulation, became
common slang after publication of Catch-22. An example of the general absurdity of
extensive paperwork appears in chapter 9: “Major Major grew more despondent as he
watched simple communications swell prodigiously into huge manuscripts.” JOSEPH
HELLER, CATCH-22 92 (Simon & Schuster 1961); see also Gerard M. Brannon,
Simplification and Other Tax Objectives, in FEDERAL INCOME TAX SIMPLIFICATION 191,
195 (Charles H. Gustafson ed., 1979) (citation omitted) (“red tape is the part of somebody
else’s business I don’t understand”).
11
OFFICE SPACE (Twentieth Century Fox 1999). Office Space became a cult classic for
its representation of office cubicle culture. “‘TPS reports,’ once just shorthand for ‘testing
procedure specifications’ in software engineering, now stand for ‘Totally Pointless Stuff.’”
Victor Fleischer, Options Backdating, Tax Shelters, and Corporate Culture, 26 VA. TAX
REV. 1031, 1035 n. 9 (2007).
12
See Andrew L. Levy, The Paperwork Reduction Act of 1980: Unnecessary Burdens
and Unrealized Efficiency, 14 J.L. & COM. 99 (1994) (one of the most substantial costs
government imposes upon its citizens is the cost of providing information for government
agencies; when Congress decides to impose such costs, an “implicit policy decision has
been made that the benefits . . . will exceed the costs to society”).
13
There is a frequent quote in legal complexity research attributed to James Madison: it
“will be of little avail to the people, that the laws are made by men of their own choice, if
the laws be so voluminous that they cannot be read, or so incoherent that they cannot be
understood.” THE FEDERALIST NO. 62, at 411–12 (James Madison) (Belknap Press 1961).
The quote also attacks constantly changing tax laws that “undergo such incessant changes
that no man, who knows what the law is today, can guess what it will be tomorrow. Law is
defined to be a rule of action; but how can that be a rule, which is little known, and less
fixed?” Id. While constantly changing rules also aggravate various forms of complexity
(e.g., “compliance” and “elaborative” complexity defined infra Part III.C), this Article
2011]
SWEATING THE SMALL STUFF
39
advisors more costly and less than “value-added” by unnecessarily
complicating tax compliance and tax planning. These shortcomings in
Congress’ tax legislation violate the spirit of the Paperwork Reduction Act
(“PRA”), which has an express purpose to minimize the paperwork burden
resulting from the collection of information by or for the federal
government.14
There have been many calls to scrap our current income tax system,
with simplification as one major goal. Attacks on the tax code seem to be
raised in every presidential campaign. 15 Proposals include alternatives to an
income tax16 or large overhauls of specific income tax provisions. 17
However, tax law is resistant to large overhaul because it has grown under
the principle of incrementalism, especially in the case of the income tax. 18
The incremental process “allows too much change” and thus “political
resistance to a broad range of demands wears thin and eventually
disappears.”19 Increasing levels of any law’s complexity are “bound to
outstrip our capacities to manage it, creating a gap between them; and
unless the forces propelling complexity can somehow be reversed, this gap
will widen.”20 This need to intervene to reduce complexity is also noticed
does not directly address this aspect (e.g., the $100 floor changing for one year only to
$500; the head of household standard deduction increasing by $50 in 2010 while all other
filing statuses remained the same). However, unstable tax law is a major complaint. See,
e.g., John D. McKinnon et al., ‘Temporary’ Tax Code Puts Nation in a Lasting Bond,
WALL ST. J., Dec. 14, 2010, at A1, A10 (citing educator deduction as an example; also
citing White House concerns that confusion over temporary provisions points to the need
for a system that is more stable and simpler).
14
44 U.S.C. §§ 3501–3520 (2006). The PRA reflects Congress’ decision that the
“Federal Government was collecting too much unnecessary information from the public”;
however, the PRA does not impose its provisions on Congress; instead, it focuses on
Executive branch agencies. Levy, supra note 12, at 120.
15
See, e.g., Jonathan Weisman, No Easy Answer on Tax Issues, WALL ST. J., Aug. 19,
2011, at A4 (Michele Bachmann, candidate for 2012 Republican nomination and a former
IRS tax attorney, believes “the tax code is too complicated and must be reformed to be
fairer and flatter”); John Harwood, Dole Proposes ‘Radical Tax Simplification,’ WALL ST.
J., Sept. 6, 1995, at A3 (Senator Dole was the 1996 Republican nominee).
16
See, e.g., HALL & RABUSHKA, supra note 2.
17
See, e.g., Steve R. Johnson, Administrability-Based Tax Simplification, 4 NEV. L.J.
573 (2004) (suggesting a decrease of pass through regimes and the elimination of
accumulated earnings tax provision).
18
JOHN F. WITTE, THE POLITICS AND DEVELOPMENT OF THE FEDERAL INCOME T AX 245–
247 (1985). Decisions on tax policy “lead to primarily marginal variations in existing
structures. . . .; they are remedial in nature, responding to general or particular needs or
problems, either within the tax system or without. . . ; and there appears to be an ongoing
process of adjustment as new values and objectives are introduced or unforeseen
consequences emerge.” Id. at 247. This “persistent hyperresponsiveness” leads to “everincreasing number of tax reduction devices and the unbelievable complexity of the tax
system.” Id. at 20.
19
Id. at 20 (emphasis in original).
20
Peter H. Schuck, Legal Complexity: Some Causes, Consequences, and Cures, 42
DUKE L.J. 1, 19 (1992).
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[Vol. 3:36
outside the law, where there is a “natural tendency” for anything that is
ordered to become disordered over time, but “something that is disordered
is highly unlikely to order itself without any additional help.” 21 Because, as
a practical matter, tax reform requires “modest, rather than sweeping,
changes,”22 this Article argues that a more manageable approach to
simplifying the tax law is to incrementally reverse its current complexity,
with a simple first step of systematically identifying and removing
immaterial provisions, along with a prohibition against future enactment of
such provisions.
This Article proceeds as follows. Part II describes the $100 floor and
educator deduction and presents data confirming how immaterial these
amounts are for government and affected taxpayers. Part II also briefly
identifies other examples of immaterial tax law provisions. Part III
discusses the general costs of complexity, with a focus on complexity
aggravated by immaterial tax law provisions. Part IV focuses on the
educator deduction and identifies it as a dramatic example of an inefficient
tax expenditure. Extending institutional economics analysis, Part IV
demonstrates that the government should internalize the educator
deduction. This tax expenditure could be more efficiently and costeffectively implemented through the Department of Education and local
school districts, as opposed to millions of teachers consummating their own
transactions. Part V offers recommendations to identify and incrementally
eliminate the clutter of immaterial tax law provisions.
II. EXAMPLES OF IMMATERIAL TAX LAW PROVISIONS
Sections A and B describe the casualty deduction’s $100 floor and the
educator deduction, respectively, and quantify their immaterial tax effect.
Section C briefly introduces examples from different areas of tax law that
have similar immaterial effect.
A. THE $100 CASUALTY & THEFT DEDUCTION FLOOR
Effective since 1964, for purposes of determining the permissible
personal casualty and theft loss deduction on Schedule A, individuals must
first reduce their loss by $100 for each casualty or theft event. 23 In 1983,
21
See, e.g., NEIL JOHNSON, TWO’S COMPANY, THREE IS COMPLEXITY 25 (2007).
Jane G. Gravelle, Practical Tax Reform for a More Efficient Income Tax, 30 VA. TAX
REV. 389, 406 (2010).
23
I.R.C. § 165(h)(1) (2006) (referencing the deductible loss under § 165(c)(3)). In 1964,
§ 165(c)(3) was amended to include the $100 floor effective after 1963. P.L. 88-272
§ 208(a)(3) and § 208(b), reprinted in 1964-1 Part 2 C.B.25. See Treas. Reg. § 1.1657(b)(4) (2010) (for casualties) and Treas. Reg. §1.165-8(c) (for thefts) for guidance on
events crossing from one year to the next year, and how to apply floors for multiple
affected parties. For 2009 only, the floor was $500. P.L. 110-343, § 706(c), (d)(1). As
noted supra note 13, rules that change from year to year are also an aggravating aspect of
complexity, but are not directly focused on in this Article. Changing rules from one year to
22
2011]
SWEATING THE SMALL STUFF
41
yet another floor was added, so that the deduction is permitted only to the
extent the casualty and theft losses, after deducting a floor of $100 per
event, exceeds 10% of adjusted gross income (AGI). 24 This is the only
deduction the Author is aware of that is subject to two floors. It appears that
a senior Senator thought the 10% of AGI floor enacted in 1983 was to
replace the $100 floor.25 The two floors are the subject of two lines on
Form 4684: line 11 for the $100 floor per event and line 19 for the
calculation to impose the floor of 10% of AGI.
The legislative history of enactment of the $100 floor reflects a desire
to avoid immaterial deductions:
It is appropriate . . . to allow the deduction only of those losses which may
be considered extraordinary, nonrecurring losses, and which go beyond
the average or usual losses incurred by most taxpayers in day-to-day
living. In view of this, . . . it is appropriate to limit the . . . deduction to
those losses . . . above a minimum amount [$100] . . . , since this
corresponds approximately with the ‘$100 deductible’ insurance carried
by many individuals. . . . This means that no deduction will be allowed in
the case of an ordinary ‘fender bending’ accident or casualty,
but . . . losses [over the floor] will continue to be deductible . . . where
they are sufficient in size to have a significant effect upon an individual’s
ability to pay Federal income taxes. 26
The legislative history contains no specific concerns of added complexity
due to the new $100 floor. However, there were numerous complaints that
the 1964 Act, which had a goal of tax simplification, actually added
complexity due to numerous new requirements, presumably including the
$100 floor.27
the next is challenging enough, but when the changes involve immaterial amounts, it
becomes frustrating.
24
I.R.C. § 165(h)(2) (2006). The 10%-of-AGI floor was enacted, effective after 1982, as
part of the Tax Equity and Fiscal Responsibility Act of 1982. P.L. 97-248 § 203(a) and (c),
reprinted in 96 Stat. 422.
25
Focusing on the “stealth” marginal tax rate increase effect of imposing AGI floors,
Democratic Minority Leader Robert Byrd noted, “[i]t is a tax increase when we raise the
minimum casualty loss a family must endure before deductions are available from $100 to
10 percent of their income.” 128 CONG. REC. S2222, 417 (Part 16) (daily ed.), Aug. 19,
1982) (emphasis added).
26
Revenue Act of 1964, Report of the Committee on Ways and Means, House of
Representatives, to Accompany H.R. 8363, at 52, Sept. 13, 1963, reprinted in 1
LEGISLATIVE HISTORY OF THE REVENUE ACT OF 1964, at 1,076 (1964).
27
Representative Bruce Alger, in noting that one of President Kennedy’s objectives was
to simplify the tax law, countered that this “of course, is a joke, and a bad one. We have
unbelievably complicated the law with deletions, deductions, changes, new rules,
conditions ad infinitum.” 109 CONG. REC. H1, 498 (daily ed. Sept. 21, 1963), reprinted in
2 LEGISLATIVE HISTORY OF THE INTERNAL REVENUE ACT OF 1964, at 17,128 (1964).
Representative John Byrnes agreed: “the code will be needlessly complex. . . . It does not
make the code less complicated. In fact, it makes it more complicated. The Commissioner
of [IRS] just the other day pointed out that the new forms that will be necessary under this
bill will be more complicated than the forms we are filing this year.” House Floor Debate
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WILLIAM & MARY POLICY REVIEW
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Like many tax provisions, the $100 floor has failed to keep up with the
times. Indeed, the legislative history for the 1983 change (imposing the
second floor of 10% of AGI) confirms that Congress recognized that $100
was an immaterial amount. The Joint Committee noted that the $100 floor
had not been raised since 1964, despite inflation of recent years, and that it
was not an appropriate measure to identify extraordinary casualty losses
“that should be taken into account by the tax system because of their
impact on an individual’s ability to pay taxes.”28 The Committee also noted
that the itemized deduction for personal casualty losses creates “significant
problems of complexity, recordkeeping, and audit for both individuals” and
the IRS.29
The following summary of Internal Revenue Service (IRS) data
demonstrates how trivial the tax effect of the $100 floor has been from
1993 to 2008 for over three million taxpayers who claimed the deduction: 30
on Conference Report, Feb. 25, 1964, at 3,443 reprinted in 4 LEGISLATIVE HISTORY OF
THE REVENUE ACT OF 1964, at 4,184 (1964).
28
STAFF OF THE JOINT COMM. ON TAXATION, JCS-38-82, GENERAL EXPLANATION OF
THE REVENUE PROVISIONS OF THE T AX EQUITY AND FISCAL RESPONSIBILITY ACT OF 1982
(P.L. 97-248) 26 (1982).
29
Id.
30
I.R.S., INDIVIDUAL INCOME TAX RETURNS PUBLICATION 1304, TABLE 2.1, RETURNS
WITH ITEMIZED DEDUCTIONS: SOURCES OF INCOME, ADJUSTMENTS, ITEMIZED DEDUCTIONS
BY TYPE, EXEMPTIONS, AND TAX ITEMS, BY SIZE OF ADJUSTED GROSS INCOME (1993–
2008), available at http://www.irs.gov/taxstats/indtaxstats/article/0,,id=96981,00.html
(1993 is the earliest year available on the IRS website). The IRS provides data by 20 bands
of AGI, with some bands based on 5,000 increments, some in multiples of hundreds of
thousands, and some in multi-million increments. The estimate of Tax Effect represents
the marginal tax cost to taxpayer (savings to government) of a $100 lost deduction,
assuming the following marginal tax rates apply after 2002: up to $10,000 of AGI: 0%;
$10,001 to $20,000: 10%; $20,001 to $50,000: 15%; $50,001 to $200,000: 25%; over
$200,000: 35%. Before 2002, the same marginal rates were employed except 38.6%,
39.1%, and 39.6% (instead of 35%) were used for 2002, 2001, and 1993–2000,
respectively, to reflect the highest marginal rates in effect those years.
2011]
Year
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
SWEATING THE SMALL STUFF
Number of Returns with
Casualty & Theft Deduction
170,112
225,085
152,270
163,674
105,413
99,459
92,231
82,596
97,424
93,738
89,781
185,261
813,976
206,287
107,474
336,746
Estimate of Tax Effect
of $100 Floor
$3,049,052
$3,929,029
$2,323,639
$2,628,291
$1,766,773
$1,644,605
$1,633,576
$1,404,267
$1,653,372
$1,744,409
$1,581,305
$3,396,165
$16,915,580
$4,144,805
$2,040,365
$7,461,215
43
Average Per
Affected Return
$17.92
$17.46
$15.26
$16.06
$16.76
$16.54
$17.71
$17.00
$16.97
$18.61
$17.61
$18.33
$20.78
$20.09
$18.98
$22.16
As demonstrated above, the amount of tax revenue to the government and
tax lost to the average taxpayer are immaterial. 31
B. THE $250 EDUCATOR DEDUCTION
Effective for the first time in 2002, for purposes of determining AGI,
eligible educators may deduct expenditures in connection with books,
supplies, computer (including related software and services) and other
equipment, and supplementary materials used in the classroom. 32 An
eligible educator is “a kindergarten through grade 12 teacher, instructor,
counselor, principal, or aide in a school for at least 900 hours during a
31
The number of returns for 2005 is much larger than other years, likely due to
Hurricane Katrina, which occurred in August 2005.
32
I.R.C. § 62(a)(2)(D) (2006). The term “supplies” does not include “nonathletic
supplies for courses of instruction in health or physical education.” Id. Originally enacted
to apply only for 2002 and 2003, the provision has been continuously extended (most
recently in the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation
Act of 2010, P.L. 111-312, § 721, reprinted in Tax Relief, Unemployment Insurance
Reauthorization, and Job Creation Act of 2010, at 50 (CCH)). In the 112th Congress,
several bills have been sent to the House Ways and Means Committee to extend the
educator deduction beyond 2011 and to increase the ceiling to $500 from $250. See H.R.
1738, 112th Cong. (2011) (making deduction permanent and increasing the maximum
deduction allowed); H.R. 694, 112th Cong. (2011) (extending by one year and increasing
the maximum); H.R. 35, 112th Cong. (2011) (extending by two years and raising the
dollar limit), status available at http://thomas.loc.gov/cgibin/bdquery/D?d112:14:./temp
/~bdlKlT::|/home/LegislativeData.php?n=BSS;c=112 (last visited Aug. 22, 2011).
44
WILLIAM & MARY POLICY REVIEW
[Vol. 3:36
school year.”33 A school is any school that “provides elementary or
secondary education (kindergarten through grade 12), as determined under
state law.”34 Provisions are included to avoid double dip benefits. 35 There
are dedicated lines on the tax return for the educator deduction: line 16 of
Form 1040A and line 23 of 1040. A taxpayer taking the educator deduction
may not file Form 1040-EZ.
Without the educator deduction, teachers were and are still permitted to
deduct these items. They are instead treated as unreimbursed employee
business expenses on Schedule A—miscellaneous itemized deductions
subject to the 2%-of-AGI floor.36 Such Schedule A deductions are at risk of
disallowance if a taxpayer is subject to alternative minimum tax.37 Thus,
teachers clearly can only benefit from taking the educator deduction (above
the AGI line) instead of itemizing it on Schedule A.
The legislative history of the educator deduction demonstrates an
attempt to provide an indirect subsidy to teachers.38 On the Senate floor,
Senator Warner noted that:
Our teachers in this country are overworked, underpaid, and all too often,
under-appreciated. . . . [Our] teachers expend significant money out of
their own pocket to better the education of our children. Most typically,
our teachers are spending significant amounts . . . out of their own pocket
on classroom expenses, such as books, supplies, pens, paper, and
computer equipment. These . . . costs place lasting financial burdens on
our teachers. This is one reason our teachers are leaving the profession.
Little wonder that our country is in the midst of a teacher
shortage. . . . [The] Federal Government can and should play a role in
helping to alleviate the Nation’s teaching shortage. . . . [We] can
encourage individuals to enter the teaching profession and remain in the
profession by providing tax relief to teachers for the costs that they incur
as part of the profession. . . . [The] provisions in this bill go a long way
33
I.R.C. § 62(d)(1)(A) (2006).
I.R.C. § 62(d)(1)(B) (2006).
35
The educator deduction is allowed only to the extent expenses exceed the amount
excludable for certain education costs under § 135 (redemption proceeds from U.S.
savings bonds), § 529(c)(1) (certain distributions from qualified tuition plans), or
§ 530(d)(2) (certain distributions from “Coverdell” savings plans). I.R.C. § 62(d)(2)
(2006).
36
I.R.C. § 67(a) (2006); Treas. Reg. § 1.67-1T(a)(1)(i) (2010).
37
I.R.C. § 56(b)(1)(A) (2006).
38
The Joint Committee reports released in connection with the enactment and the
extensions do not elaborate on the purpose of the deduction. See, e.g., STAFF OF THE JOINT
COMM. ON TAXATION, JCX-55-10, TECHNICAL EXPLANATION OF THE REVENUE
PROVISIONS CONTAINED IN THE “TAX RELIEF, UNEMPLOYMENT INSURANCE
REAUTHORIZATION, AND JOB CREATION ACT OF 2010” (P.L. 111-312) (2010); STAFF OF
THE JOINT COMM. ON TAXATION JCX-75-08, TECHNICAL E XPLANATION OF H.R. 7060, THE
“RENEWABLE ENERGY AND JOB CREATION TAX ACT OF 2008,” (AS SCHEDULED FOR
CONSIDERATION BY THE HOUSE OF REPRESENTATIVES ON SEPTEMBER 25, 2008) (P.L. 110343) (2008).
34
2011]
SWEATING THE SMALL STUFF
45
toward providing our teachers with the recognition they deserve by
providing teachers with important and much needed tax relief. 39
President Bush aired similar remarks at a teacher conference shortly after
the bill’s enactment:
We support teachers who sacrifice for their students. I don’t know if
people realize this, but on the average, teachers . . . now spend $400 out of
their pocket to pay for supplies. My first reaction is, that’s not
right. . . . But in that they do have to do it, it makes sense to allow a
teacher to deduct that expense. If a business person can deduct a meal, a
teacher certainly ought to be able to deduct the cost of pencils or a Big
Chief tablet. Teachers need our support.40
There are no regulations related to the educator deduction. 41 The only
guidance from the IRS has been periodic reminders for educators to save
receipts.42
In their annual update in Florida Tax Review on tax law changes (and
extenders, such as the educator deduction), the authors offered a sarcastic
comment on the immateriality of this provision: “Since we are not willing
to pay school teachers a living wage, let’s give them a tax break worth less
than $2 a week at their tax brackets.”43 Evidence of this immateriality is
provided in the following summary of IRS data on the educator
deduction:44
39
148 CONG. REC. S1689, S1691 (daily ed. Mar. 8, 2002) (statement of Sen. Warner).
Senator Warner and the legislative history of the Job Creation and Worker Assistance Act
of 2002 do not elaborate on what is arguably an overstatement: that a teacher would quit a
job because of what we will see is one dollar a week.
40
President Bush Remarks, President Joins Mrs. Bush at Teacher Quality Conference,
Mar. 5, 2002, http://www.georgewbush-whitehouse.archives.gov/news/releases/2002/03/
20020305-4.html. Note that the bill included not only the educator deduction but also other
provisions related to funding education more directly.
41
For court cases addressing whether taxpayers had supporting documentation to
evidence their educator deduction, see infra notes 161–62 and accompanying text.
42
See, e.g., I.R.S. News Release 2007-158 (Sept. 11, 2007), available at
http://www.irs.gov/newsroom/article/0,,id=173811,00.html (“With the new school year
now under way, the [IRS] today reminded teachers, parents and students that saving
receipts and keeping good records can help them take advantage of various educationrelated deductions. . . . Good recordkeeping makes sense because it can help avoid missing
a deduction or credit at tax time”). Nearly identical language was used in other years. See,
e.g., I.R.S. Information Release 2002-65 (May 21, 2002), available at
http://www.unclefed.com/Tax-News/2002/nr02-65.html); I.R.S. Information Release
2003-106 (Sept. 2, 2003), available at http://www.irs.gov/newsroom/article/0,,id=
112593,00.html; I.R.S. News Release 2005-82 (Aug. 16, 2005), available at
http://www.irs.gov/newsroom/article/0,,id=146231,00.html.
43
Martin McMahon, Jr. et al., Recent Developments in Federal Income Taxation: The
Year 2008, 9 FLA. TAX REV. 275, 302 (2009).
44
I.R.S., supra note 30, TABLE 1.4, ALL RETURNS: SOURCES OF INCOME, ADJUSTMENTS,
AND TAX ITEMS, BY SIZE OF ADJUSTED GROSS INCOME (2002–2008). The estimate of Tax
Effect assumes the same marginal tax rates as used supra note 30, multiplied by the
amounts of deductions taken. The teacher typically saves slightly more, as many states
piggyback the Code’s definition of AGI. On the other hand, the marginal tax benefit is
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Year
Number of Returns
with Educator
Deduction (000’s)
Amt of
Deduction
(000’s)
Avg Amt of
Deduction per
Return
Estimated Tax
Effect of
Deduction (000’s)
Avg Per
Affected
Return
2002
2,884
$712,505
$247.02
$153,773
$53.31
2003
3,241
$805,734
$248.63
$173,650
$53.58
2004
3,402
$858,457
$252.30
$185,991
$54.66
2005
3,504
$877,796
$250.53
$193,150
$55.13
2006
3,167
$805,568
$254.37
$181,223
$57.22
2007
3,654
$925,997
$253.41
$206,675
$56.56
2008
3,753
$947,072
$252.32
$212,049
$56.50
As demonstrated above, materiality is lacking. The average affected
teacher’s savings are approximately one dollar a week. 45
C. OTHER EXAMPLES OF IMMATERIAL TAX LAW PROVISIONS
What one person might think is immaterial, another might think is
material. In seeking to identify legal complexity, several authors have
played on the words of Justice Potter regarding pornography: “I know it
when I see it.”46 Besides knowing immateriality when we see it, one might
even say “immateriality is in the eye of the beholder.”
While the evidence provided above demonstrates how immaterial the
educator deduction and the $100 floor are, what other tax provisions are
immaterial? As immaterial as these provisions are, the amount of work and
ink required to document their triviality are far from immaterial. To provide
general evidence that income tax and other tax law is replete with similarly
immaterial provisions, this section provides brief highlights of a potpourri
of other examples that the Author has non-scientifically identified.
slightly overstated because some taxpayers could have deducted them on Schedule A as a
miscellaneous deduction. Note that the table for the educator deduction has two columns
(“Amount of Deduction” and “Average Amount of Deduction per Return”) that are not
present in the prior table for the casualty and theft deduction floor. This is because the
earlier table had a fixed amount ($100) per affected tax return, while the table for the
educator deduction extracts information from the IRS as to how much was deducted by
taxpayers (i.e., it is not an automatic $250).
45
It is possible that a teacher may view this $1 a week at their individual level as
material while society as a whole might view the aggregate amount as immaterial.
However, as demonstrated infra Section IV and as recommended infra Section V, society
would be more efficiently served if government funded the expenditures directly (to
reduce transaction costs, the total of which likely outweighs the benefit to the individual
teacher). Thus, the teacher would no longer lose the $1 because government would directly
fund it instead of through an inefficient tax expenditure.
46
See, e.g., R. George Wright, The Illusion of Simplicity: An Explanation of Why the
Law Can’t Just Be Less Complex, 27 FLA. ST. U.L. REV. 715 (2007) (“We think, for
example, that we can easily recognize legal complexity when we see it”). In seeking to
identify complexity, one author notes “I know it when I read it.” Lance W. Rook, Laying
Down the Law: Canons for Drafting Complex Legislation, 72 OR. L. REV. 663, 669 n. 22
(1993) (paraphrasing Jacobellis v. Ohio, 378 U.S. 184, 197 (1964) (Potter, J., dissenting)).
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47
The first set relates to the tax law’s treatment of the time value of
money. For example, as a general proposition, the Author agrees we need a
penalty if an individual fails to timely pay estimated taxes (“2210
penalty”).47 Even with relatively low interest rates (and 2210 penalty rates)
over the last decade, successful investors and self-employed taxpayers
could derive a large time value benefit not available to the typical worker
(who has taxes withheld at source) if no 2210 penalty existed. However,
there are far too many immaterial modifications and exceptions.
For example, do we really need Section 6654(j)? This provision
collapses the first two estimated tax installments normally due April 15 and
June 15 to one payment due June 15 for non-resident aliens.48 In essence,
this provision allows two months of time value savings on tax deferrals. At
recent 2210 penalty rate levels, and considering the extensive withholding
at source provisions for non-resident aliens, this is another case of sweating
the small stuff. Similarly, one of the “safe” exceptions to the 2210 penalty
is paying an amount equal to last year’s tax. 49 However, there is an
exception to this exception if AGI was over $150,000 in the prior year, in
which case the taxpayer avoids the penalty if the amounts paid equal or
exceed 110% of the prior year tax. 50 Thus, such a taxpayer would lose the
time value of interest on 10% of last year’s tax. Based on IRS data for
2008, the resulting 2210 penalty was no more than $120 million spread
over 6.4 million tax returns, or less than $20 per affected tax return. 51
The stimulus rebates, which apply in isolated years but to a majority of
taxpayers, also present unnecessary complications. The most recent was
enacted in February 2008—the so-called Bush rebate in the Economic
Stimulus Act of 2008. The tax rebates were calculated based on tax return
data but implemented through a separate payment process that presented
many complications and unnecessary transaction costs.52
47
I.R.C. § 6654(a) (2006).
I.R.C. § 6654(j) (2006).
49
I.R.C. § 6654(d)(B)(ii) (2006).
50
I.R.C. § 6654(d)(C) (2006). As more evidence of immaterial provisions, this rule was
phased in from 1998 to 2002 at various rates, with one year as low as 5% greater than the
prior year tax and another year as high as 12% greater than the prior year. I.R.C.
§ 6654(d)(C)(i) (2006).
51
Ten percent of approximately $1.2 billion in 2210 penalties is $120 million. I.R.S.,
supra note 30, TABLE 2, ALL RETURNS: TAX LIABILITY, TAX CREDITS, AND T AX
PAYMENTS, BY SIZE OF ADJUSTED GROSS INCOME (2008). The amounts reported in the text
are a rough estimate because the aggregate 2008 data includes all taxpayers, not just those
who had AGI over $150,000 in 2007. If we run a similar calculation for those with AGI
over $100,000 in 2008 (there is no band starting at $150,000), the amount is approximately
$35 per tax return.
52
See Stanley Veliotis, A Better Way to Get Tax Rebates to Taxpayers, 118 TAX NOTES
1325, Mar. 24, 2008 (demonstrating inefficiencies of the enacted process and proposing
simpler alternatives); Stanley Veliotis, Stimulus Tax Rebate Deadline Poses Problems for
Some U.S. Expatriates, 49 TAX NOTES INT’L 791, Mar. 3, 2008 (showing how many
expatriates arriving abroad in 2007, who normally had to wait until January 2009 to file
48
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Another set of tax law provisions that drive all but the rare taxpayer to
require professional help are those related to how much one can deduct for
mileage when using their own car. Taxpayers may deduct standard mileage
rates for using a car for certain purposes (such as business) instead of
providing receipts, and these rates are revised periodically by the IRS to
reflect current costs of operating a car. 53 But why must the rates for
charitable use of one’s car (fixed under statute at 14 cents per mile 54) be
different from use for medical or moving purposes (19 cents for the first
half of 201155 and 23.5 cents for the second half56). Why must the rates be
revised so frequently for something that is such a trivial difference? If a
taxpayer drives from California to start a new job in New York, the extra
4.5 cents per mile leads to an added deduction of approximately $130—at a
maximum tax bracket of 35%, this saves approximately $40 for a rarely
encountered situation.
Immateriality also applies for other taxes assessed on Form 1040. For
example, in computing AMT, for purposes of deducting medical expenses,
the 7.5% of AGI floor normally used on Schedule A 57 is adjusted to 10% of
AGI.58 This complication is in our law even though only about 7% of all
tax returns are able to itemize medical expense and only 8% of itemizers
are subject to AMT; given that the vast majority of medical itemizers are in
AGI levels for which AMT normally does not apply, it is likely that a
percentage far below 0.5% of tax returns require this adjustment.59 As to
self-employment tax, this is generally due if the net earnings are $400 or
more; however, this amount is reduced to $100 for certain church
personnel. 60 An additional SE tax receipt to government of approximately
$40 per applicable impacted taxpayer is clearly a case of sweating the small
stuff, as well as inefficient when considering complications such as
identifying who qualifies as church personnel? 61
their first tax return using Section 911’s foreign earned income exclusion under the socalled bona fide residence test, would fail to obtain the rebate, which requires the tax
return to be filed by the end of 2008).
53
See, e.g., Notice 2010-88, 2010-51 I.R.B. 882 (Dec. 23, 2010); Ann. 2011-40, 201129 I.R.B. 56 (June 23, 2011).
54
I.R.C. § 170(i) (2006).
55
Notice 2010-88, supra note 53.
56
Ann. 2011-40, supra note 53.
57
I.R.C. § 213(a) (2006).
58
I.R.C. § 56(b)(1)(B) (2006).
59
140 million returns are filed annually. I.R.S., INDIVIDUAL INCOME TAX RETURNS,
HISTORICAL TABLE 2, INDIVIDUAL INCOME AND TAX DATA, BY STATE AND SIZE OF
ADJUSTED GROSS INCOME (1996, 2009), available at http://www.irs.gov/taxstats/
article/0,id=171535,00.html. Only 10 million returns itemized medical expense in 2008.
Out of 46 million returns that itemized deductions, only 3.8 million had AMT. I.R.S.,
supra note 30, TABLE 2.1 (2008).
60
I.R.C. §§ 1402(j)(2)(A), 1402(j)(2)(B) (2006).
61
I.R.C. § 1402(j)(4) (2006).
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49
This Article focuses on individuals and not entities or business settings.
However, there are also many immaterial provisions in these settings. For
example, why do we need a $250 floor on the allowed disabled access
credit?62 Do we really need a one year change in the phase-out starting
point of deductibility of start-up expenses from $50,000 to $60,000?63
Turning to trusts (which are not necessarily used just by the wealthy), there
is also unnecessary complication by the immaterial difference between the
exemptions for complex versus simple trusts (the exemption is either
$10064 or $30065), which leads to an immaterial difference of at most $70.
This Article focuses on the federal tax law. There are also immaterial
provisions in state and local tax law, although, of course, the burdens of
each state’s rules apply to far less taxpayers than the federal tax law. For
example, New York allows a real property credit of up to $75 (up to $375 if
at least one member of the household is over 65) based on the value of the
home (as well as other items such as maximum household income of any
type (tax free or not) of $18,000); however, the taxpayer is not allowed a
credit if the home is worth over $85,000.66 Even with the downturn in
home prices, very few taxpayers, even outside expensive New York City,
are likely eligible for this credit. New York data appears to support this. In
a summary of 28 different credits, including the real property credit, taken
on 2008 tax returns, New York granted credits for a grand total of $863,000
for those with AGI under $15,000 (out of 5.7 million resident tax returns). 67
Also, if we look at business settings at the state level, the Wall Street
Journal recently summarized nearly comical examples of recent sales tax
questions answered by New York (e.g., edible aloe leaves are not subject to
sales tax but only if they are not sold in potted form).68
III. THE COST OF TAX COMPLEXITY DUE TO
IMMATERIAL TAX RULES
Many areas of law suffer from complexity. 69 However, the federal
income tax law is probably the poster child for legal complexity. 70 It is
62
I.R.C. § 44(a) (2006).
I.R.C. § 195(b)(3)(B) (2006).
64
I.R.C. § 642(b)(2)(A) (2006).
65
I.R.C. § 642(b)(2)(B) (2006).
66
NEW YORK DEPT. OF T AXATION AND FINANCE, PUBL’N NO. 22, 5 (Dec. 1, 2010).
67
NEW YORK DEPT. OF T AXATION AND FINANCE, ANALYSIS OF 2008 PERSONAL INCOME
TAX RETURNS, Apr. 2011, 16–17, 35, 44, available at http://www.tax.ny.gov/
pdf/stats/stat_pit/pit/analysis_of_2008_personal_income_tax_returns.pdf.
The
real
property tax credit is included in “Other credits”, which total $47 million for those with
AGI under $10,000 and $818 million for those with AGI between $10,000 and $15,000.
Id. at 44.
68
Jacob Gershman, Answers to Many Taxing Questions, WALL ST. J., Dec. 28, 2010, at
A1.
69
Schuck, supra note 20, at 19 (citing fields as diverse as agency regulation, trusts and
estates, and torts).
63
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difficult to think of an area of law that affects more individuals and
organizations in the U.S.71 So it comes as no surprise that federal income
tax law complexity has long been studied. 72 In effect, much of the research
seeks to answer the following question: “How . . . could the tax system be
reformed to reduce the ‘economic friction’ of transaction costs?” 73
Section A generally describes how tax regulation introduces transaction
costs and deadweight losses. In a sense, the tax law presents a monopolistic
setting that American citizens cannot escape and thus the taxpayer pays the
price for inflated transaction costs. This is a most dangerous form of
monopoly because of the lack of ability for market forces to discipline the
tax agency for inefficiently determining the tax bill. Section B generally
identifies the overall burdens and costs of tax complexity. Section C
identifies the types of complexity aggravated by immaterial tax laws, with a
focus on the $100 floor and the educator deduction.
A. MARKETS’ INABILITY TO DISCIPLINE GOVERNMENT FOR TAX
COMPLEXITY-INDUCED COSTS
In nearly any setting in which parties deal with one another, transaction
costs result. A broad definition of transaction costs are those expenditures
70
See, e.g., id. at 4.
There are approximately 300 million Americans. U.S. CENSUS BUREAU, POPULATION
DISTRIBUTION AND CHANGE: 2000 TO 2010, TABLE 1, 2 (March 2011), available at
http://www.census.gov/prod/cen2010/briefs/c2010br-01.pdf. Approximately two-thirds
annually file an income tax return. I.R.S., supra note 30, TABLE 1.2, ALL RETURNS:
SOURCES OF INCOME, ADJUSTMENTS, AND TAX ITEMS, BY SIZE OF ADJUSTED GROSS
INCOME (2007) (approximately 140 million individual returns were filed for 2009; this
represents filings by nearly 200 million individuals after factoring in that nearly fifty-four
million returns are “married filing jointly”). For the remaining one-third of Americans who
did not file a return, clearly it would be the rare case if any of those individuals never
confronted a tax law. Many non-filers are retirees whose standard deductions and
exemptions exceed their AGI. Weisman, supra note 15. Earlier in their lives many of these
retirees filed income tax returns. Also, many non-filers are not yet adults with sufficient
gross income to trigger a filing; as they enter adulthood, many will confront income tax.
72
Literature addressing the need for simplification has been growing since shortly after
the income tax was enacted. Charles H. Gustafson, Introduction, in FEDERAL INCOME T AX
SIMPLIFICATION, supra note 10, at 8 (citing simplification efforts in 1926 and 1954). As
complexity has grown, so has relevant scholarship over the last several decades. See, e.g.,
FEDERAL INCOME T AX SIMPLIFICATION, supra note 10 (American Law Institute’s 1978
conference on simplification); James S. Eustice, Tax Complexity and the Tax Practitioner,
45 TAX L. REV. 7 (1989); Charles A. McLure, Jr., The Budget Process and Tax
Simplification/Complication, 45 TAX L. REV. 25 (1989); Deborah H. Schenk,
Simplification for Individual Taxpayers: Problems and Proposals, 45 TAX L. REV. 121
(1989); Pollack, supra note 1; Samuel A. Donaldson, The Easy Case Against Tax
Simplification, 22 VA. TAX REV. 645 (2003); Gravelle, supra note 22.
73
Kneave Riggall, Comprehensive Tax Base Theory, Transaction Costs, and Economic
Efficiency: How to Tax Our Way to Efficiency, 17 VA. TAX REV. 295, 324 (1997); see also
Schuck, supra note 20, at 19 (“Like friction in mechanics, [transaction costs] are
ubiquitous and limit the system’s performance”).
71
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51
two or more parties expend in negotiating and enforcing a contract. 74
Transaction costs present deadweight losses that waste resources or reduce
efficiency. 75 While economic research has traditionally focused on
transaction costs in dealings between private parties, 76 research on
transaction costs has expanded to government regulation. 77
Through lawmaking of any type, government inevitably is at risk of
inflating transaction costs. Any area of law that is considered complex
“entails many significant transaction costs because such law tends to be
more costly and cumbersome to administer, more difficult for lawmakers to
formulate and agree upon, and more difficult to reform once established.” 78
It is costly for administrators and subjects to learn what the law means,
when and how it applies, as well as to have disputes about the rules,
necessitating the services of lawyers and other professionals trained in
managing complexity. 79 Complexity thus “can inhibit beneficial
transactions, impose deadweight losses, create frustrating delays, consume
the energies of talented individuals, breed new and difficult-to-resolve
disputes, and discourage compliance.” 80 In sum, complexity interferes with
efficiency. 81
74
David M. Driesen & Shubha Ghosh, The Functions of Transaction Costs: Rethinking
Transaction Cost Minimization in a World of Friction, 47 ARIZ. L. REV. 61, 62 (2005).
This definition of transaction costs suffices for the discussion in Part III. However, see
infra notes 184–199 and accompanying text for an elaborated definition of transaction
costs in the context of institutional economics. See also infra note 93 for how tax law
implies a contract between government and taxpayer.
75
See, e.g., STEPHEN M. BAINBRIDGE, CORPORATION LAW AND ECONOMICS 26–27
(2002); Jeff Sovern, Toward a New Model of Consumer Protection: The Problem of
Inflated Transaction Costs, 47 WM. & MARY L. REV. 1635, 1683–84 (2006) (citing
example of the process of mailing in consumer rebates (instead of immediate price
reduction) as creating transaction costs). Such deadweight loss occurs repeatedly when
parties are “willing to incur the transaction costs necessary to protect their interests.” Id. at
1685. Most taxpayers feel compelled to exhaust every effort (incur transaction costs) to
minimize their tax bill (protect their interests). Tax complexity presents a recipe for
deadweight losses.
76
See, e.g., Sovern, supra note 75 (consumer and seller). See also extensive discussion
infra Part IV.A in connection with institutional economics.
77
See, e.g., Oliver E. Williamson, Public and Private Bureaucracies: A Transaction
Cost Economics Perspective, 15 J.L. ECON. & ORG. 306 (1999).
78
Schuck, supra note 20, at 18.
79
Id.
80
Id. at 19; see also JAMES L. PAYNE, COSTLY RETURNS: THE BURDENS OF THE U.S.
TAX SYSTEM 87–89 (1993) (in addition to time and money taxpayers spend on tax
compliance, compliance costs deter taxpayers from undertaking socially productive
activities).
81
Efficiency and simplicity/complexity, along with equity, are the three traditional
criteria for evaluating a tax. Donaldson, supra note 72, at 732. There is an interaction
between efficiency and complexity in that the “benefit of simplicity is its advancement of
the standards of efficiency.” Id. at 743. The “desire for simplicity is in essence a reflection
of the cost standard to taxpayers and the administrability standard to the government. A
52
WILLIAM & MARY POLICY REVIEW
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As to tax law, there are many transaction costs “inherent in the tax
system itself.” 82 They include costs “incurred by government in writing
and enacting” Code provisions, regulations, and other pronouncements
“upon which the tax system is built, by taxpayers in complying with [those
rules], and by all parties in enforcing the laws and regulations when the
government perceives a lack of compliance.”83 As in other regulatory
settings, “resources devoted to dealing with tax complications are a dead
weight loss to society”; they should be subtracted from efficiency gains of a
given tax law provision.84
Addressing “why inflated transaction costs are objectionable almost
seems unnecessary.”85 However, in the context of tax regulation, these
costs are even more objectionable because of an inability for subjects to
“shop elsewhere.” In perfectly competitive markets, inefficient
organizations risk failing if they cannot keep costs down.86 Businesses that
do not engage in continuous process improvement lose market share to
other firms as the consumer metes out discipline. 87 The efficiency of
determining the price of a good or service is also an important aspect of a
consumer’s assessment of the overall value of the purchase. 88 For example,
if price and all else is equal, a consumer will prefer one vendor to another if
the former’s invoicing is clearer to understand. 89
simple tax in theory is more likely to present fewer compliance and opportunity costs for
taxpayers, and fewer enforcement costs for the government.” Id.
82
Riggall, supra note 73, at 320.
83
Id.
84
Brannon, supra note 10, at 195; Deborah L. Paul, The Sources of Tax Complexity:
How Much Simplicity Can Fundamental Tax Reform Achieve?, 76 N.C. L. REV. 151, 211
n. 238 (1997).
85
Sovern, supra note 75, at 1683.
86
Competition leads to marginal cost pricing (i.e., firm X sells at a price equal to its
marginal cost). If not, more efficient firms (new entrants or current competitors) will
undercut X’s selling price and drive X out of business.
87
For example, a manufacturer that cannot reduce “throughput time” (the time it takes to
manufacture a product) is at risk of losing to another manufacturer who minimizes
throughput time. RAY GARRISON ET AL., SELECTED MATERIALS FROM MANAGERIAL
ACCOUNTING 471–72 (12th ed. 2008). Private firms also implement other cost-minimizing
and efficiency-increasing processes through approaches such as “lean thinking” and “Six
Sigma.” See, e.g., id. at 13–14, 16–17.
88
Discovering the price presents transaction costs (e.g., “using the price mechanism;”
see infra note 177 and accompanying text). For an interesting view that government uses
marketing techniques to obfuscate the “price” of taxes, see Aradhna Krishna & Joel
Slemrod, Behavioral Public Finance: Tax Design as Price Presentation, 10 INT’L TAX &
PUB. FIN. 189 (2003).
89
For example, marketing research has long found that price bundling (as opposed to
multiple listing of component prices) “often can and should decrease price sensitivity and
increase purchase likelihood.” Dilip Soman & John T. Gourville, Transaction Decoupling:
How Price Bundling Affects the Decision to Consume, 38 J. MKTG. RES. 30 (2001) (citing
papers). Anyone who has bought an automobile can attest to the frustration of reading the
multiple supplemental charges that are applied after he thought he had negotiated a final
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However, in settings lacking competition (e.g., monopoly), the results
are different. Economists have long identified businesses operating as a
monopoly as another source of inefficiency or deadweight loss. 90 Indeed,
the federal government and its taxing arm operate as a monopoly. 91 We can
view taxpayers as captive buyers92 of government services for which a
price (tax rate) is extracted via the tax code’s definition of taxable
income. 93 In the case of most monopolistic settings, the consumer may
personally escape (i.e., participants have a basic right to exit organizations
that inflict unacceptable demands).94 Even in most governmental settings, if
constituents do not want to be subject to ordinances of their municipality’s
government, they might physically move to a preferred municipality. 95
Unfortunately, individual taxpayers do not have this freedom at the federal
“price.” See also Rebecca W. Hamilton et al., When Should You Nickel-and-Dime Your
Customers?, MIT SLOAN MGMT. REV., Oct. 1, 2010, available at
http//sloanreview.mit.edu/the-magazine/2010-fall/52108/when-should-you-nickel-anddime-your-customers/ (addressing when a seller should charge separately for various
extras, and when is it better to keep things simple by combining all of the charges into one
total price).
90
See, e.g., RICHARD B. MCKENZIE & DWIGHT R. LEE, IN DEFENSE OF MONOPOLY: HOW
MARKET POWER FOSTERS CREATIVE PRODUCTION 1, 30–34 (2011); WILLIAM W.
SHARKEY, THE THEORY OF NATURAL MONOPOLY 12–20 (1982) (discussing history of
monopoly).
91
Government has a true natural monopoly. RANDALL G. HOLCOMBE, THE ECONOMIC
FOUNDATIONS OF GOVERNMENT 37–38, 92–95 (1994); Joseph E. Stiglitz, On the
Economic Role of the State, in THE ECONOMIC ROLE OF THE STATE 52 (Arnold Heertje ed.,
1989); see also Williamson, supra note 77, at 339 n. 11 (noting that government is the
ideal organization to collect income taxes, although it can outsource “routine operating
duties” related to tax collection to obtain greater efficiency).
92
Economists also use the term “locked-in consumers.” See, e.g., MCKENZIE & LEE,
supra note 90, at 96.
93
Phrased differently, government possesses the power to tax so that it can provide
public goods that citizens desire but cannot provide for themselves through “voluntary
bilateral interactions” and those public goods that cannot be provided optimally by the
market. Geoffrey Brennan, Tax Limits and the Logic of Constitutional Restrictions, in TAX
AND E XPENDITURE LIMITATIONS 124–26 (Helen F. Ladd & T. Nicolaus Tideman eds.,
1981). A way of viewing taxpayers’ interaction with government’s taxing arm is through a
contract lens. MYRON SCHOLES ET AL., TAXES AND BUSINESS STRATEGY, A PLANNING
APPROACH 3 (4th ed. 2009). The income tax law presents a profit sharing contract in which
the taxpayer must pay a portion of earnings to the IRS, as agent for the silent partner, the
federal government. The contract defines earnings via the calculation of taxable income
under the Code. Id. In a private contract setting, it would be no surprise if a court struck
down a provision of a contract as unconscionable if it contained the types of terms
included in the tax law. See JOSEPH M. PERILLO, CALAMARI & PERILLO ON CONTRACTS
388–389, 399 (5th ed. 2003) (noting growing body of case law subverting the duty to read
if the adhesion or other standard form contract is unconscionable; examples of
unconscionability include unequal bargaining power or where oppression and unfair
surprise could occur).
94
Stiglitz, supra note 91, at 21.
95
Id. at 21; HOLCOMBE, supra note 91, at 94.
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level because they must pay tax on their worldwide income regardless of
where they reside.96
B. THE COSTS OF TAX COMPLEXITY
Tax complexity and inefficiency lead to costs for both government and
taxpayer. For government, complexity becomes expensive as funds are
spent on developing rules and forms. 97 Complexity also makes enforcement
“significantly more difficult, and it makes it easier for taxpayers to plead
ignorance or error when the intent was truly fraud.”98 Ultimately, the
government’s incurred costs due to “complexity are spread over all
taxpayers.”99
As to taxpayers, an inefficient tax requires more compliance and
opportunity costs.100 It is less efficient if a rule requires taxpayers to
maintain separate records, which obviously adds burdens and confusion for
taxpayers.101 A less efficient income tax also requires more compliance
time; this introduces not only out-of-pocket costs but also opportunity
costs, as “presumably the taxpayer could apply the time and resources lost
to compliance toward the production of additional income.” 102
Because of the “extraordinary complexity” in filing tax returns, it is
“[n]o wonder” so many Americans, at all income levels, hire tax preparers
“to tell them what to do.”103 Thus, tax complexity increases fees paid to tax
advisors or tax software providers, as well as the value of time expended
directly by taxpayers. 104 IRS data reveals that the percentage of tax returns
with a paid preparer for 2009 has increased by approximately 13% since
96
To be precise, it is only U.S. citizens and “green card” holders (lawful permanent
residents) who cannot escape because they are taxed on worldwide income. I.R.C.
§§ 7701(a)(30), 7701(b)(1)(A)(i) (2006). Absent renunciation of their citizenship or green
card, which has its own set of difficult tax consequences (e.g., I.R.C. § 877), they do not
have the ability to “shop elsewhere” or “vote with their feet.” See also Stiglitz, supra note
91, at 21 (one organization that an American citizen may not exit is that of the federal
government’s tax arm).
97
Edward J. McCaffery, The Holy Grail of Tax Simplification, 1990 WIS. L. REV. 1267,
1291 (1990). See also Donaldson, supra note 72, at 696–98 (citing data, including IRS
issuance of guidance).
98
WITTE, supra note 18, at 62.
99
McCaffery, supra note 97, at 1291. See also Donaldson, supra note 72, at 743 (“an
efficient tax should be one that the government can enforce relatively easily”; if not,
“resources dedicated to collection and enforcement strains the tax base to produce
additional revenues to cover these additional costs”).
100
Donaldson, supra note 72, at 742.
101
Id.; Pollack, supra note 1, at 356; Schenk, supra note 72, at 166–67 (complex
recordkeeping requirements breed noncompliance).
102
Donaldson, supra note 72, at 742. Complying with the “labyrinthine tax regulations is
frustrating, costly and intrusive.” JOEL SLEMROD & JAN BAKIJA, TAXING OURSELVES 3
(4th ed. 2008).
103
GRAETZ, supra note 2, at 14 (reporting that over 60% hire preparers, a percentage
more than this Author calculates (see infra note 105 and accompanying text)).
104
HALL & RABUSHKA, supra note 2, at 7–12.
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1996, from 44% to slightly over 57%. 105 Meanwhile, individuals’ purchase
of tax software has increased dramatically over the last decade as more and
more individuals have access to home computers and the internet. 106 A
2009 report estimates that 22% of individual taxpayers purchase and use
tax software.107 Thus, it appears that nearly 80% of tax returns require paid
assistance.
One might argue that we need not be concerned about complexity
because 80% of individual taxpayers use preparers or software (and
presumably a large portion of the remaining 20% are prepared by taxpayers
(or their friends or family) who themselves are experts in taxation).
However, there are three responses. First, complexity would still need to be
absorbed by these experts.108 Second, under Professor Bittker’s “mass
provisions” concept, the tolerable level of complexity is a function of the
sophistication and cost-bearing capacities of those who will interpret and
implement the particular rule.109 Complexity is tolerable when addressed to
experts applying rules to uncommon transactions, but it creates problems
when addressed to numerous non-experts with common situations and
transactions.110 Bittker attaches “primary importance” to simplifying
provisions that affect millions of taxpayers, even if the dollar amount per
taxpayer is small and the complexity mild when compared to more difficult
areas such as trust and corporations. 111 Third, for most Americans, using
professional help still does not solve all their problems—often they do not
105
Eighty-one million of 141 million (slightly over 57%) individual income tax returns
filed for 2009 were prepared by a paid preparer, while 53 million out of 121 million
(approximately 44%) returns for 1996 had paid preparers. I.R.S., HISTORICAL TABLE 2,
INDIVIDUAL INCOME AND TAX DATA, BY STATE AND SIZE OF ADJUSTED GROSS INCOME,
TAX YEAR 2009, available at http://www.irs.gov/taxstats/article/0,id=171535,00.html.
I.R.S., Historical Table 2, Individual Income and Tax Data, by State and Size of Adjusted
Gross Income, Tax Year 1996, available at http://www.irs.gov/taxstats/article/0,id=
171535,00.html.
106
For 2010, Intuit, the maker of the best-selling Turbotax home consumer software
product, reports $1.15 billion of net revenue from “consumer tax,” which primarily
represents sales of Turbotax. Form 10-K for Year Ending July 2010, at 98. This is
approximately four times greater than 2001, when net revenue was $272 million. Form 10K for Year Ending July 2003, at 29 (showing historical data).
107
Nina E. Olson, Op-Ed, We Still Need a Simpler Tax Code, WALL ST. J., Apr. 10, 2009,
at A13. Nina Olson is the national taxpayer advocate.
108
Of course, to the extent we surrender details of tax preparation to such professionals,
there is some efficiency in having several hundred thousand experts learn a rule instead of
the entire population. But see Charles A. McLure, Jr., A Few Things the Tax Reform Panel
Needs to Remember, 58 NAT. TAX J. 367, 368 (2005) (tax software, like Turbotax, is a
“mixed blessing;” it simplifies tax return preparation but it “converts return preparation
into a ‘black box’ operation” and it “makes taxpayers codependent with a dysfunctional
Congress that continually enacts legislation, much of which has little redeeming social
value”).
109
Boris I. Bittker, Tax Reform and Tax Simplification, 29 U. MIAMI L. REV. 1, 5 (1974).
110
Schuck, supra note 20, at 45–46.
111
Bittker, supra note 109, at 5.
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even know of requirements (such as to keep a receipt for educator
expenses) until they obtain assistance in the early part of the following
year; by that time they may not be able to obtain the necessary
documentation. 112
Billions of hours are spent every year in the U.S. on “fundamentally
unproductive tax-related activities such as record keeping, wading through
instructions, [and] hunting for deductions and credits.” 113 One author
calculated $0.65 is spent to determine and collect every dollar raised in
taxes,114 while Arthur Laffer, known for the Laffer curve, recently more
conservatively measured a cost markup of $0.30.115
So far we have addressed the obvious out-of-pocket costs and not so
obvious opportunity costs, such as wasted hours. What of indirect
consequential costs arising from taxpayers erring on the side of lowering
their tax bills? Voluntary compliance, “so critical to the tax law’s integrity,
depends upon its intelligibility.” 116 If increased complexity leads to
taxpayers not comprehending what the law requires, then the “rule of law
has been abandoned as an operative principle.” 117 These “delegitimization
costs are great” because taxpayers “bewildered” by complexity and
uncertainty appear more likely to violate the tax law. 118 For example,
taxpayers find the array of confusing forms and schedules so complex that
they are “convinced that they do not know what forms to use and that, even
if they did, they could not properly complete them; [so,] they simply do not
try.”119
The next section addresses how much of the complexity described
above is due to immaterial tax law provisions.
112
Deborah H. Schenk, Simplification for the Average Taxpayer, in FEDERAL INCOME
TAX SIMPLIFICATION, supra note 10, at 115, 119.
113
SLEMROD & BAKIJA, supra note 102, at 3–4, 161 (citing three billion hours of
taxpayer time spent on annual tax returns). There are several annual estimates. See, e.g.,
GRAETZ, supra note 2, at 14 (income tax is “so complex and riddled with perverse
incentives,” leading to 3.5 billion hours and $150 billion of “wasted money”); HALL &
RABUSHKA, supra note 2, at 2 (billions of dollars to administer and comply); Olson, supra
note 107 (as of 2009, 7.6 billion hours are spent by individuals and businesses).
114
PAYNE, supra note 80, at 149–50.
115
Arthur B. Laffer, Op-Ed, The 30-Cent Tax Premium, WALL ST. J., Apr. 18, 2011, at
A15; see also Riggall, supra note 73, at 320 (these regulatory costs (transaction costs in
running the tax system) “can be a very substantial burden on the economy, perhaps a
greater burden than the taxes themselves”).
116
Schuck, supra note 20, at 24.
117
Pollack, supra note 1, at 358 (“In many respects, this has become the sad state of tax
policymaking.”).
118
Schuck, supra note 20, at 23. If “taxpayers think the whole system is unknowable, the
temptation to use self help to fashion their own private tax shelters becomes well nigh
irresistible.” Eustice, supra note 72, at 19.
119
Schenk, supra note 112, at 116 (footnotes and citation omitted).
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C. TAX LAW COMPLEXITY DUE TO IMMATERIAL LAWS
Three traditional criteria for evaluating a tax are simplicity, equity and
efficiency. 120 However, simplicity and its opposite, complexity, are “the
hardest to define and the hardest to apply with any meaningful
precision.”121 To help identify the consequences of immaterial tax laws, “it
is useful to distinguish between several aspects of . . . complexity.”122
One type of tax complexity is what one author calls “judgmental
complexity,” which results from the tax law wrestling with the substantive
tax treatment of a transaction or relationship. 123 We expect these settings to
require lengthy and complicated rules. Think of imputing interest income
on below-market rate loans,124 disallowing double benefits when claiming a
foreign tax credit when a taxpayer has already avoided U.S. tax on a
foreign item of income, 125 or imputing foreign taxes paid as income to a
120
Donaldson, supra note 72, at 732. Decades earlier the core goals of tax policy were
described slightly differently, though with similar implications for complexity. Brannon,
supra note 10, at 192 (“my big three tax policy objectives [are] equity, efficiency, and
political acceptability. Simplification and its opposite, complexity, can best be thought
about as being an element of these basic objectives. . . .”). See also Donaldson, supra note
72, at 743 (“It is a mistake to distinguish simplicity as a tax policy criterion distinct from
efficiency. Simplicity is part of what scholars mean by efficiency, nothing more.”).
121
Donaldson, supra note 72, at 732 (“In defining simplicity, one might start by defining
its opposite—complexity”). No “consensus exists as to what makes a tax simple.” Id. at
732–33.
122
McLure, supra note 72, at 42. See also Wright, supra note 46, at 716 (complexity “is
much more complex than we imagine. There are, it turns out, any number of more or less
separate and independent kinds of complexity in the law”). This Article generally focuses
on the kinds of complexity aggravated by immaterial provisions. For samplings of other
kinds of complexities, see, e.g., Paul, supra note 84 n. 4, and Donaldson, supra note 72 n.
428.
123
John A. Miller, Indeterminacy, Complexity, and Fairness: Justifying Rule
Simplification in the Law of Taxation, 68 WASH. L. REV. 1, 12 (1993) (judgmental
complexity refers to “intellectual, moral, and philosophical burdens a tax question may
pose” for even seasoned tax advisors, such as “When should a transaction be taxed
according to its substance rather than its form? When should several transactions occurring
in sequence be taxed according to their end result? Is a certain transaction a realization
event? What is the true economic nature of a certain transaction?”).
124
I.R.C. § 7872 (2006). This codified example of substance-over-form recharacterizes
what, according to its form, is a “non-transaction” to its substance (symmetrical imputed
interest income/expense for lender/borrower, and the characterization of the imputed
round-trip of the foregone interest as compensation, dividend or gift, depending on the
relationship between the lender and borrower). For a recent simplification suggestion, see
John A. Lynch, Jr., Taxation of Below-Market Loans under § 7872: This Could Be a Lot
Simpler!, 23 AKRON T AX J. 33, 34 (2006) (Section 7872 introduced a very complex
provision at a time when the broader call was for tax simplification).
125
I.R.C. § 911(d)(6) (2006). Section 911 allows an often generous exclusion of foreign
earned income for Americans working abroad. I.R.C. § 911 (2006). However, to avoid a
double-dip benefit, the expatriate must “scale down” those foreign taxes attributable to the
excluded income. Taxpayers and their counsel often grapple with whether the taxpayer
should eschew the § 911 exclusion so as to optimize use of foreign tax credits. See, e.g.,
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U.S. corporation when repatriating overseas income from its controlled
foreign corporation.126 While tax rules involving judgmental complexity
are intellectually tempting to analyze and critique (and fodder for many a
law review article), this type of complexity is not the focus of this
Article.127 Instead, we now turn to the tedium of analyzing immaterial nonsubstantive provisions and the facets of complexity they unnecessarily
create.
Complexity of any set of laws is obviously associated with the number
of elements or components involved, such that the greater the number of
parts, the greater the complexity. 128 Intuitively, tax complexity refers in
part to the regime’s “complication,” namely the “number and detail of the
legal authorities that define the regime.” 129 One author refers to “density”
as reflecting rules that are numerous and encompassing. 130 Another author
offers “elaborative complexity” to label tax complexity relating to the
information (and education) that must be absorbed to begin to decide a tax
question, including the length, detail, and interconnectedness of tax rules,
even if the rules themselves are relatively simple. 131 The Joint Committee
Shirley Dennis-Escoffier, Tax Planning Opportunities for U.S. Taxpayers Abroad, 78
PRACTICAL T AX STRATEGIES 12, 22–24 (2007).
126
I.R.C. § 78 (2006). Generally, a U.S. corporate parent does not consolidate with its
CFC on the former’s U.S. corporate tax return and the U.S. does not tax CFCs’ income
until repatriated to the U.S. parent. This is a complicated provision because the income
taxed by the U.S. arises when the dividend is paid to the U.S. parent but the foreign taxes
considered for foreign tax credit include not only any foreign taxes paid on the dividend
but also the foreign taxes paid on the CFC’s related income as earned (I.R.C. § 902(a)
(2006)), and there is gross up of the CFC’s net income to add back the foreign taxes
(I.R.C. § 78 (2006)). For elaboration, see, e.g., Julie A. Robin, The Grand Illusion, A
Neutral System for the Taxation of International Transactions, 75 VA. L. REV. 919, 937–
939 (1989) (article describes many complications related to U.S. corporations and their
CFCs); BORIS I. BITTKER & JAMES S. EUSTICE, FEDERAL INCOME T AXATION OF
CORPORATIONS AND SHAREHOLDERS ¶ 15.21[2][e] (online ed., Warren Gorham &
Lambert 2011).
127
Unlike the types of complexity caused by immaterial tax law provisions, much of the
causes of judgmental complexity “cannot be altered.” Stanley S. Surrey, Complexity and
the Internal Revenue Code: The Problem of the Management of Tax Detail, 34 L. &
CONTEMP. PROBS. 673, 708 (1969). Note that Surrey’s reference to “detail” is not to the
trivial nature targeted in this Article, but rather the necessary detail required to effect
complex tax analysis of complex transactions and relationships.
128
Wright, supra note 46, at 716–17, 723–25 (citing tax law as an example). See also this
Article’s prior quotation attributed to James Madison: it “will be of little avail to the
people, that the laws are made by men of their own choice, if the laws be so voluminous
that they cannot be read. . . .” THE FEDERALIST, supra note 13 (emphasis added).
129
Paul, supra note 84, at 154. The federal income tax is often criticized for the
abundance and intricacy of rules and standards in the Code and regulations. Such a regime
is complicated because it has numerous detailed authorities. Id. at 158–59. See also
Donaldson, supra note 72, at 733 (large number of rules evidences complexity).
130
Schuck, supra note 20, at 3.
131
Miller, supra note 123, at 12. By “education,” nothing in Miller’s article implies
formal education of the reader such as a degree in law or accounting. Elaborative
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also identifies “computational complexity” to describe the setting in which
numerous and tedious calculations are required to determine tax liability. 132
The growing number of our tax rules evidences the overall level of
density or what might also be called “clutter”133 complexity. As of 2006,
the Code had nearly 10,000 sections.134 The Code and regulations consists
of nearly eight million words.135 However, instead of reading the Code or
regulations, most taxpayers consult the IRS forms and related
instructions. 136 These also have grown over time. In 1977, Form 1040 had
over seventy lines calling for information.137 By 2010, the form had eightytwo line numbers (including the educator deduction on line 23), along with
an additional two dozen “sub-lines” not present in 1977.138 The
complexity can be seen to also include what one author refers to as “technicality” (rules
that “require special sophistication or expertise on the part of those who wish to
understand and apply them”) (Schuck, supra note 20, at 4) and what another author,
writing about tax complexity for four decades, calls “rule complexity” (the difficulty in
understanding and interpreting legislative and regulatory rules) (Deborah H. Schenk,
Exploiting the Salience Bias in Designing Taxes, 28 YALE J. REG. 253, 261 (2011)). See
also Steven A. Dean, Tax Deregulation, 86 N.Y.U. L. REV. 387, 410–11 (2011), for
similar definition of rules complexity.
132
STAFF OF THE JOINT COMM. ON TAXATION, STUDY OF THE OVERALL STATE OF THE
FEDERAL TAX SYSTEM AND RECOMMENDATIONS FOR SIMPLIFICATION, PURSUANT TO
SECTION 8022(3)(B) OF THE INTERNAL REVENUE CODE OF 1986, at 42, 101 (2001),
available at www.jct.gov/s-3-01vol1.pdf [hereinafter OVERALL STATE]. “Complex or
numerous calculations increase both the time it takes for taxpayers to fill out returns and
the likelihood of errors.” Id. at 42.
133
Clutter increases compliance and enforcement costs because specific answers
“become buried as the number of authorities increases.” Paul, supra note 84, at 158.
134
Wright warns that reducing the number of code sections by expanding each section’s
length is not necessarily a way to reduce complexity. Wright, supra note 46, at 725. Thus,
it is not necessarily the case that 10,000 sections are such a high number that they are per
se complex.
135
SLEMROD & BAKIJA, supra note 102, at 160. As of 2001, the Code had 1.4 million
words. OVERALL STATE, supra note 132, at 4. By 2009, the Code had 3.7 million words,
nearly tripling since 1975. Olson, supra note 107. In 1913, the Code and regulations were
first published by CCH in a single volume consisting of slightly over 400 pages; by 1994,
they had grown to eight volumes. Pollack, supra note 1 n. 3.
136
Meade Emory, Two Aspects of Tax Complexity: The IRS and What it can do; The
Quest for Simplicity Cannot Become a Drive for Further Tax Breaks, in FEDERAL INCOME
TAX SIMPLIFICATION, supra note 10, at 439, 443 (it is not the substance of the tax law
itself (Code and regulations) but through the IRS’ forms and publications that “almost all
taxpayers get their taste of” tax law complexity).
137
Schenk, supra note 112, at 116–17 (apparently counting as lines those that call for
qualitative information such as name and address, based on this Author’s review of the
1977 form available at http://www.taxhistory.org/thp/1040forms.nsf/WebByYear/
1977/$file/1040_1977.pdf).
138
Form 1040 (2010), available at http://www.irs.gov/pub/irs-prior/f1040--2010.pdf.
This Author reports 82 lines to be consistent with the approach in Schenk (e.g., including
qualitative information). The number of data insertions are actually more than 82 because
in recent years some lines now include separate details in sub-lines (e.g., various credits
for which taxpayers check relevant box on lines 53 and 71 for 2010). Id. For a historical
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accompanying instructions to Form 1040 increased from fifty-two relevant
pages (and 137 index entries) for 1980139 to ninety-eight pages (and 174
index entries) by 2010. 140
The problems associated with density complexity are “a function of
human frailty[;] when there are more rules to know than we can readily
assimilate, the law is complex in a very practical sense.” 141 This problem
exists “even though the individual rules themselves are relatively
simple.”142 Why would even simple rules (e.g., including a second floor of
$100 for the allowable casualty deduction) be difficult to understand when
they are voluminous?
Research based in psychology focuses on cognitive burdens, including
overload.143 Information overload has long been known to negatively
impact humans’ ability to efficiently and effectively process information
and make decisions.144 Cognitive load theory posits that complex problem
solving consumes working memory by requiring the capture of problem
detail and goal states in working memory. 145 This presents cognitive
challenges because working memory, which holds current information, is
very limited. 146 There are various heuristics and cognitive biases (what
could be called “mental compromises”) long identified in psychology and
trend of the increases in lines in forms, see David Keating, A Taxing Trend: The Rise in
Complexity, Forms, and Paperwork Burdens, NTU Policy Paper 127 (Nat’l Taxpayers
Union), Apr. 15, 2010, available at http://www.ntu.org/ntu-pp-127-tax-complexity2010.pdf.
139
Form 1040 Instructions (1980), available at www.irs.gov/pub/irs-prior/i1040-1980.pdf. 1980 is the earliest year for which instructions are available on the IRS website.
140
Form 1040 Instructions (2010), available at www.irs.gov/pub/irs-pdf/i1040.pdf.
141
Miller, supra note 123, at 12; see also Schuck, supra note 20, at 19 (complexity “tests
our capacities”).
142
Miller, supra note 123, at 12.
143
Economists tend to focus on “bounded rationality” when addressing human frailty.
See infra notes 194–95 and accompanying text.
144
See, e.g., Claudia Klausegger et al., Information Overload: A Cross-National
Investigation of Influence Factors and Effects, 25 MARKETING INTELLIGENCE & PLANNING
691, 693 (2007) (focusing on consumer decisions but also summarizing dozens of studies
of effect of information overload on decision makers). For example, in marketing research,
the volume of disseminated advertising has been growing but the “human capacity to
absorb and make sense of this swollen flow of attempted persuasion hasn’t changed one
iota.” Leo Bogart, Cutting Through the Clutter, in STRATEGY IN ADVERTISING 127 (NTC
Business Books, 3rd ed. 1995). This “[i]ncreased clutter reduces attention, recall, and
registration.” Id. at 148 (noting that this clutter “has little effect on consumer attitude and
purchase intention”).
145
John Sweller, Cognitive Load During Problem Solving, 12 COGNITIVE SCIENCE 257,
285 (1988). Information overload theory also applies in legal settings. See, e.g., Jay
Tidmarsh, Unattainable Justice: The Form of Complex Litigation and the Limits of
Judicial Power, 60 GEO. WASH. L. REV. 1683, 1766 (1992).
146
Alan D. Baddeley, Working Memory: The Interface between Memory and Cognition,
4 J. COGNITIVE NEUROSCIENCE 281, 288 (1992) (lay decision makers are unable to cope
with massive or complicated evidence).
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behavioral economics literature that help decision makers cope with
overload and other consequences of complexity. 147 Research in the tax area
has identified these heuristics as also applying to taxpayers148 and tax
professionals. 149
The tax literature has identified yet another form of complexity,
“compliance complexity,” 150 which clearly is aggravated by immaterial
provisions such as the educator deduction. This type of complexity relates
to “keeping records, filling out forms, and so forth.”151 It is a “popular
misconception” that average taxpayers do not face compliance
complexity. 152 Indeed, it is compliance complexity that “probably
primarily” concerns most taxpayers with “relatively simple financial
affairs.”153 Another author distinguishes “record keeping complexity” from
his definition of compliance complexity: “how in the world does one fill
out the forms.”154
Immaterial tax law provisions clearly present unnecessary density
(clutter) and compliance complexity. Adding a line 23 to Form 1040’s
already lengthy page 1 for the educator deduction clearly makes the form
denser.155 Similarly, Form 4684, the casualty deduction schedule that cross
references to Schedule A’s casualty deduction line, is also made more
dense because of the added $100 floor on its line 11. Notice how less dense
(and more consistent with the presentation of Schedule A’s medical and
miscellaneous expenses’ floors) the casualty deduction could be if the $100
147
See, e.g., GERD GIGERENZER ET AL., SIMPLE HEURISTICS THAT MAKE US SMART 16–
17 (Oxford Univ. Press 1999) (search for alternatives or more information must be
terminated at some point, at which point a “final set of heuristic principles can be called
upon to make the decision . . . based on the results of the search”).
148
See, e.g., Schenk, supra note 131, at 254 (“in making decisions, individuals rely on
heuristics or cognitive biases”); Edward J. McCaffery & Jonathan Baron, Thinking about
Tax, 12 PSYCH. PUB. POL. & L. 106, 111–12 (2006) (the usual heuristics and biases in
people are even more acute when considering their understanding of, and attitudes about,
tax; this is due to general tax complexity and low benefits for any individual to personally
obtain a full understanding, among other reasons). For empirical work showing that
density complexity burdens taxpayers, see, e.g., Susan B. Long & Judyth A. Swingen, An
Approach to the Measurement of Tax Law Complexity, 8 J. AM. TAX. ASS’N 22, 32 (1987)
(numerous calculations, detailed rules, record keeping).
149
See, e.g., Michael J. Roberts, Tax Accountants’ Judgment/Decision-Making Research:
A Review and Synthesis, 20 J. AM. TAX. ASS’N 78–79 (1998).
150
See, e.g., McLure, supra note 72, at 42.
151
McLure, supra note 72, at 42. See also Dean, supra note 131, at 411; Donaldson,
supra note 72, at 698–704; McCaffery, supra note 97, at 1272; Schenk, supra note 131, at
261; Schenk, supra note 112, at 119; DAVID BRADFORD, UNTANGLING THE INCOME T AX
266–67 (1986).
152
Schenk, supra note 72, at 128.
153
McLure, supra note 72, at 42.
154
Joshua D. Rosenberg, A Helpful and Efficient IRS: Some Simple and Powerful
Suggestions, 88 KY. L.J. 33, 55 (1999).
155
A large step in reducing clutter and other complexity would be to remove the
distinction between deductions for AGI and deductions from AGI (Schedule A).
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floor was eliminated, leaving the material 10% of AGI floor as the only
floor. Arguably, removing the $100 floor (and perhaps moving the 10% of
AGI floor to Schedule A in a format as the 2% miscellaneous/7.5% medical
floors appear) might lead to eliminating Form 4684, or at least cutting it
down from two pages to one page.
Furthermore, the Code and regulations themselves are unnecessarily
denser because of these immaterial items. In the Code, the educator
deduction, including the definition of eligible educator, contains over 200
words.156 There are no regulations for the educator deduction, although
there are numerous lengthy IRS announcements.157 For the $100 floor for
the casualty deduction, there are over fifty words in the Code, while the
regulations contain over 800 words.158 For both these immaterial
provisions, note also the extensive number of words needed in extender and
amendment provisions that made denser their respective years’ legislative
history and legislation (e.g., the floor’s increase to $500 for 2009 only; the
four separate extenders on the educator deduction, as well as several bills
pending to extend beyond 2011159).
We also have a third branch of government involved with tax law.
Decisions of the judiciary further increase the size and number of relevant
authorities. Nearly forty Tax Court cases (and two Oregon tax court cases)
reference the $100 floor, with many including the floor in a headnote.160
There have been seven court cases involving the educator deduction. One
case involved the taxpayer incorrectly listing more than $500 ($250 for
each spouse).161 The remaining cases addressed whether the taxpayer
appropriately documented the expenses. For example, in one case, the court
found the record “devoid of credible evidence” that taxpayers were entitled
to any educator expense deductions because they neither testified as to
what educator expenses they made nor produced receipts or other credible
evidence evidencing such expenses.162
Compliance complexity is aggravated by the educator deduction
because record keeping is necessary for many who normally would not
keep tax records as they do not itemize their deductions. 163 Thus, they need
156
I.R.C. §§ 62(a)(2)(D), 62(d) (2006).
See supra note 42.
158
I.R.C. § 165(h)(1) (2006); Treas. Reg. § 1.165-7(b)(4) (for casualties); Treas. Reg.
§ 1.165-8(c) (for thefts).
159
See supra note 32.
160
Based on the Author’s Lexis search on August 22, 2011 in Tax Law Library of
Federal and State tax cases (search term: “$100” in the same paragraph as “165(h)(1)”).
161
Alston v. Comm’r, T.C. Summ. Op. 2007-155 (Sept. 5, 2007).
162
Basalyk v. Comm’r, 97 T.C. (CCH) 1516 (2009).
163
According to the Bureau of Labor Statistics, the mean 2010 salary for the nearly 3.4
million teachers of kindergarten (occupation code 25-2012), elementary (25-2021), middle
(25-2022) and secondary (25-2031) school was approximately $55,000. MAY 2010
NATIONAL OCCUPATIONAL EMPLOYMENT AND WAGE ESTIMATES, UNITED STATES
[hereinafter Wage Estimates], available at www.bls.gov/oes/current/oes_nat.htm#25157
2011]
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to keep records of the up-to-$250 of relevant expenses. Even the IRS
believed it necessary to release announcements notifying and reminding
teachers to keep their receipts.164
Furthermore, both the $100 floor and educator deduction aggravate
technical complexity. 165 Taxpayers have to understand to apply the second
floor of $100 in the calculation of the permissible casualty deduction, that
they must apply it once per event, but not multiply the 10% of AGI floor by
the number of events. For the educator deduction, the teacher must first
ascertain whether he qualifies as an eligible educator for an eligible school,
and whether the expenditures are eligible expenses. He must also figure out
where to deduct the educator expenses (e.g., up to $250 ($500 if two
teachers are married filing jointly) on line 23 and the remainder, if any, on
Schedule A (including subjecting it and other miscellaneous expenses to a
2% of AGI floor, which in turn is disallowed under AMT)). (Part IV infra
formally addresses the transaction costs presented by the educator
deduction’s compliance complexity and technicality complexity when this
Article argues that the educator deduction tax expenditure should be
repealed, with government instead directly funding the expenditure).
As noted above, complexity leads to delegitimization concerns. An
example of this may well be that many teachers find it “well nigh
irresistible”166 to deduct the full $250 for educator expenses, even if they
have not expended that full amount or even if they or their expenditures did
not qualify. The data presented in Part III.B, showing that the average
deduction is between $247 and $254 (very close to the $250 cap), suggests
this possible result. 167 Notice also that nearly 3.8 million tax returns used
0000. It is likely many do not itemize. IRS statistics for 2008 report that 16.2 million (out
of approximately 100 million returns) with AGI under $55,000; 9.2 million of these 16.2
million returns reported miscellaneous deductions subject to the 2% floor. I.R.S., supra
note 30, TABLE 3, RETURNS WITH ITEMIZED DEDUCTIONS: ITEMIZED DEDUCTIONS BY TYPE
AND BY SIZE OF ADJUSTED GROSS INCOME, TAX YEAR 2008 (this statistic is offered for a
general approximation; of course, many teachers are married and likely file joint returns
on which their spouse’s income is also included, and thus AGI is higher; also, many
teachers may be married to spouses with much higher income).
164
See supra note 42.
165
Technicality is identified as another aspect of elaborative complexity. See supra note
131.
166
Eustice, supra note 72, at 19.
167
Recall that $254 is greater than $250 because of the cases of some married filing joint
returns representing two teachers. When consulting IRS data segregated based on filing
status, we see that the average educator deduction taken by single taxpayers is between
$226 and $234 for each of the years 2002 to 2008. I.R.S., supra note 30, TABLE 1.3, ALL
RETURNS: SOURCES OF INCOME, ADJUSTMENTS, DEDUCTIONS, CREDITS, AND T AX ITEMS,
BY MARITAL STATUS, TAX YEARS 2002–2008. This is also very close to the cap of $250.
However, if the average of $400 expenditures reported by President Bush (supra note 40
and accompanying text) is accurate, then this Author’s suspicions that taxpayers are
overstating their deduction is possibly flawed. Indeed, it would appear that the cap of $250
per teacher is acting as a constraint and forcing taxpayers to itemize the excess on
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the educator deduction in 2008. If even a small portion of these returns are
married couples who are both educators, the number of teachers taking this
deduction likely exceeds four million, very close to the number of teachers
there are in this country, 168 which implies that it is the rare teacher who
does not claim the educator deduction. Could it really be that every teacher
in this country is altruistic or dedicated enough to dip into their own pocket
to fund classroom materials? The reported averages reveal a pattern similar
to that documented in a recent study finding that taxpayers are more likely
to report just less than $500 of non-cash donations instead of just more than
$500, presumably to take advantage of a reduced audit risk by not
completing the relevant schedule required when non-cash donations exceed
$500.169
Finally, one cannot merely cast off immaterial tax laws’ aggravation of
complexity because, for 80% of tax returns, taxpayers have given up trying
to do their own tax returns. Bittker’s “mass” principle 170 tolerates
complexity when tax advisors are needed for the uncommon transaction.
Unfortunately, on an annual basis, the educator deduction affects nearly
four million teachers and the $100 casualty floor affects often over 100,000
filers. Also, taxpayers may not have known to keep receipts for the
educator deduction until their advisor or software advises them early in the
following year (although this problem normally is not repeated in future
years for those teachers who learned from prior year experience to keep
receipts).
IV. IMMATERIAL TAX EXPENDITURES: AN INSTITUTIONAL
ECONOMICS APPROACH TO THE EDUCATOR DEDUCTION
The term “tax expenditure” refers to the fact that many U.S. tax laws
are “intended not as necessary structural parts of a normative tax, but rather
as tax incentives or hardship relief provisions[; these] provisions are thus
Schedule A, which has several limits to successful use there (see supra notes 36 and 37
and accompanying text).
168
There are nearly 3.4 million kindergarten, elementary, middle, and secondary school
teachers according to Department of Labor statistics. Wage Estimates, supra note 163.
While these are not the only four categories of eligible educators, they would appear to be
the vast majority of all eligible educator positions.
169
Steve Buchheit et al., Noncash Charitable Giving: Evidence of Aggressive Taxpayer
Reporting Following a Compliance Change, 27 J. AM. TAX. ASS’N 1 (2005). The study
exploited the natural experiment setting presented by Treasury Decision 8002, which
relaxed the substantiation requirements for deducting noncash charitable contributions
under $501 after 1984. The study found that the relatively stable percentage of taxpayers
who claimed zero noncash charitable deductions in years prior to TD 8002 decreased
consistently and significantly after TD 8002’s implementation. The decrease was largely
replaced by taxpayers who reported noncash charitable deductions for amounts just under
the $501 limit.
170
See supra notes 109–11 and accompanying text.
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really spending measures.”171 In essence, Congress transforms and
supplements the role of the IRS from that of tax collector into administrator
of spending programs. 172 The “tendency to implement more and more
domestic policy” through tax expenditures “accounts for a large portion of
the increased magnitude and complexity of the tax laws.”173 These “tax
subsidies tumble into the law without supporting studies, being propelled
instead by clichés, debating points, and scraps of data and tables that are
passed off as serious evidence.” 174 Incrementalism is at work here too, as
the trend of increasing tax expenditures “itself breeds further complexity
[because it] is very difficult to argue for the rejection of one more tax
expenditure program on the ground of simplicity when that single program
is to be added to an already tangled structure.”175
The educator deduction is a tax expenditure. Educators incur costs to
buy materials for the classroom. They are partially subsidized by the
federal (and possibly state) government because the taxpayer is permitted
to deduct up to $250 of such expenditures for purposes of determining their
AGI whether or not they itemize their deductions on Schedule A. In
essence, the government is not buying these materials but instead funds an
amount equal to the respective marginal tax rates of the paying educators,
who incur the net cost to the extent of one minus their marginal tax rate.
The taxpayers also incur transaction costs in purchasing the materials and
managing the tax return process, while the government avoids some
transaction costs (primarily related to purchasing) but incurs other
transaction costs (primarily related to monitoring (audit risk)).
171
Stanley S. Surrey & Paul R. McDaniel, The Tax Expenditure Concept and the
Legislative Process, in THE ECONOMICS OF T AXATION 123–24 (Henry J. Aaron & Michael
J. Boskin ed., 1980).
172
GRAETZ, supra note 2, at xi.
173
Pollack, supra note 1, at 341. See also Paul R. McDaniel, Federal Income Tax
Simplification: The Political Process, in FEDERAL INCOME TAX SIMPLIFICATION, supra
note 10, at 507, 528–29 (tax expenditures constitute a major source of complexity); Eric T.
Laity, The Corporation as Administrative Agency: Tax Expenditures and Institutional
Design, 28 VA. TAX REV. 411, 425 (2008) (“traditional analysis asserts that tax
expenditures contribute to [tax] complexity and thus increase the cost to government of
administering the tax system and the cost to taxpayers of complying”); GRAETZ, supra
note 2, at xi (politicians ask tax law to “do too much” through tax expenditures, which
leads to “a level of complexity that baffles experts, let alone ordinary Americans at tax
time”). But see David A. Weisbach & Jacob Nussim, The Integration of Tax and Spending
Programs, 113 YALE L.J. 955, 981–82 (2004) (“The usual argument that putting programs
into tax system increases complexity . . . is correct if one looks only at the tax system. But
if one considers government policy as a whole, integration within the tax system may often
be a choice for simplicity” compared to another agency); McDaniel, supra note 173, at
529 (moving from one agency (IRS as tax expenditure administrator) to another
governmental agency through an identical direct program merely shifts the complexity
from one governmental unit to another).
174
JEFFREY L. YABLON, AS CERTAIN AS DEATH: QUOTATIONS ABOUT T AXES 58 (Tax
Analysts 2010) (quoting Stanley Surrey).
175
Gustafson, supra note 72, at 7.
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This part extends institutional economics 176 analysis to the educator
deduction tax expenditure. Section A provides a brief review of
institutional economics. While this literature traditionally refers to the
“firm” and “markets,” it is not difficult to imagine the concept of the firm
and markets being replaced by government and taxpayers, respectively, as
developed in Section B. Section C analyzes the relative efficiency of the
governmental organization directly expending the funds to buy educator
materials and four million individual taxpayers individually purchasing
them.
A. INSTITUTIONAL ECONOMICS APPROACH AND EXPANDED DEFINITION
OF TRANSACTION COSTS
In his 1937 seminal article on whether transactions are ideally executed
“within firms” or in markets (i.e., outside firms), Ronald Coase explained
that the “main reason why it is profitable to establish a firm would seem
[the] cost of using the price mechanism[, the] most obvious cost [being]
that of discovering what the relevant prices are [as well as] costs of
negotiating and concluding a separate contract for each exchange
transaction.”177 Two decades later, Coase elaborated:
[T]o carry out a market transaction it is necessary to discover who it is
that one wishes to deal with, to inform people that one wishes to deal and
on what terms, to conduct negotiations leading up to a bargain, to draw up
the contract, to undertake the inspection needed to make sure that the
terms of the contract are being observed, and so on. These operations are
often extremely costly, sufficiently costly at any rate to prevent many
transactions that would be carried out in a world in which the pricing
system worked without cost.178
Oliver Williamson summarizes compactly (in relevant part):
“(a) markets and firms are alternative instruments for completing a related
set of transactions; (b) whether a set of transactions ought to be executed
[within a firm or outside] depends on the relative efficiency of each mode;
[and] (c) the costs of writing and executing complex contracts across a
market vary with the characteristics of the [impacted] human decision
176
Some also refer to this area as “transactional cost economics.” This Article prefers the
term “institutional economics” to avoid confusion with transaction costs, as discussed
more generally infra Part III.A, and to focus the reader on the ultimate issue: which
“institution” is the better choice to effect the educator material purchases: government or
teacher (four million of them). Also, some refer to this area as “new” institutional
economics to distinguish it from “old” institutional economics. See Ronald H. Coase, The
New Institutional Economics, 88 AM. ECON. REV. 72 (1998).
177
Ronald H. Coase, The Nature of the Firm, 4 ECONOMICA 386, 390–91 (1937). The
notions of Coase are “prevalent among nonmathematical writers—notably those who treat
issues in law and economics.” Carl J. Dahlman, The Problem of Externality, 22 J.L. &
ECON. 141, 147 (1979).
178
Ronald H. Coase, The Problem of Social Cost, 3 J.L. & ECON. 1, 15 (1960).
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makers.”179 In other words, organizing economic activity within a firm may
lower search and other transaction costs associated with bargaining. 180
Transaction costs “make transactions more costly and less likely to
occur.”181 By having a “transaction-cost free zone”182 within a firm, these
transactions are more likely to occur, or occur at a cheaper cost.
Before extending the “nature of the firm” discussion above to
governmental activities, it is useful to elaborate on and extend the
definition of transaction cost beyond how that term was used in Part III.
With all transactions, there are two kinds of costs to be concerned about:
(1) direct out-of-pocket costs to purchase a good or service (e.g., the price
the battery maker charges the car manufacturer for a battery) and (2) the
related transaction costs.183
Research in law-and-economics has “suffered from the absence of an
accepted vocabulary for disaggregating the general notion of transaction
costs.”184 One can view transaction costs along two dimensions:
chronological (i.e., “whether it was incurred at a pre-bargain, bargain, or
post-bargain stage”) and functional. 185 There are “three somewhat
overlapping functional categories” of transaction costs.186 First, “gettogether costs are the burdens of arranging . . . connections among
transacting parties” (e.g., “establishing lines of communication, setting up
meetings, and transporting . . . goods”).187 Second, “decision and execution
costs” are the costs to actualize the agreement and document the deal. 188
179
OLIVER E. WILLIAMSON, ANTITRUST ECONOMICS: MERGERS, CONTRACTING, AND
STRATEGIC BEHAVIOR 74 (1987).
180
BAINBRIDGE, supra note 75, at 26–27, 33–35.
181
Id. See also RONALD H. COASE, THE FIRM, THE MARKET, AND THE LAW 175 (1988)
(some contracts will not be “undertaken because making the contractual arrangements
necessary to bring them in to existence would cost more than the gain they make
possible”).
182
Carliss Y. Baldwin, Where Do Transactions Come From? Modularity, Transactions,
and the Boundaries of Firms, 17 IND’L & CORP. CHANGE 155, 157–58, 180–88 (2008).
183
Driesen & Ghosh, supra note 74, at 62 (“One can best understand transaction costs by
contrasting them with production and purchase costs”); Francois Melese et al., Applying
Insights from Transaction Cost Economics to Improve Cost Estimates for Public Sector
Purchases: The Case of U.S. Military Acquisition, 10 INT’L PUB. MGMT. J. 357, 359
(2007) (“two costs are typically factored into the ‘make-or-buy’ decision: production costs
and the costs of managing transactions—‘transaction costs’”). For example, “production
cost advantages of outsourcing often guide companies to specialize in ‘core’ activities in
which they have a comparative advantage, and to ‘transact’ with outside suppliers
(outsource) to acquire other goods and services[: a] key contribution” of transaction cost
economics is the formal consideration of “the nontrivial costs of managing those
transactions.” Id. at 359.
184
Robert C. Ellickson, The Case for Coase and against “Coaseanism,” 99 YALE L.J.
611, 614 (1989) (“A tidy categorization is probably not possible.”).
185
Id. at 614–15.
186
Id.
187
Id. at 615.
188
Id.
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Third, “information costs” include information as to the procured item’s
price, quality, and other terms of transfer. 189 “Factual information of these
sorts is obtained through inspection, research, and bargaining.”190 A wouldbe acquirer may go through a “process of search” (e.g., “arranges gettogethers with, and makes factual inquiries of, potential trading
partners”).191
While some might imply that transaction costs are “money both sides
expend,”192 there are other less obvious costs, three of which are
uncertainty, complexity and opportunism. 193 The first two relate to the
limitations of human decision makers, formally labeled as bounded
rationality, which refers to a condition in which human agents are
“intendedly rational, but only limitedly so.”194 Economic agents who are
boundedly rational are able to “receive, store, retrieve, and process only a
limited amount of information” supplied to them in relation to their
capacity to use it effectively. 195
On the other hand, opportunism goes beyond human cognitive limits. 196
It reflects humans’ less innocent side. Opportunism relates to the fact that
human agents are “inevitably tempted to pursue their own self-interest.”197
Opportunism “extends the usual motivational assumption of self-interest to
make allowance for self-interest with guile.”198 Opportunism is also closely
189
Id.
Id. at 615–16. Another author offers three categories: identification costs, negotiation
costs, and enforcement costs. Peter G. Toumanoff, A Positive Analysis of the Theory of
Market Failure, 37 KYKLOS 529, 531 (1984); see also Melese et al., supra note 183, at 359
(noting that transaction costs include coordination and motivation costs such as search and
information costs, decision and contracting costs, and monitoring and enforcement costs).
191
Ellickson, supra note 184, at 616. One author argues that search and information
costs, bargaining and decision costs, policing and enforcement costs are, in the end, “one
type” of transaction cost: costs due to “imperfect information.” Dahlman, supra note 177,
at 148.
192
Driesen & Ghosh, supra note 74, at 62 (emphasis added).
193
BAINBRIDGE, supra note 75, at 34. Bainbridge defines complexity as a result of
attempts to reduce to writing the contractual agreement (e.g., how each will react to a
specific situation). Id. This is not the kind of complexity normally aggravated by
immaterial tax law provisions.
194
WILLIAMSON, supra note 179, at 75, 126 (coupling uncertainty with psychologist
Herbert Simon’s bounded rationality).
195
Id. at 126 (noting that “the economics of attention is an important but generally
neglected item on the research agenda”). The efficient processing of information is an
important and related concept of transaction costs; but for the “limited ability of human
agents to receive, store, retrieve, and process data, interesting economic problems vanish.”
Oliver E. Williamson, Transaction-Cost Economics: The Governance of Contractual
Relations, 22 J.L. & ECON. 233, 234 n. 5 (1979).
196
Bounded rationality is related to “human frailty” in terms of cognition and decision
making. See discussion infra notes 141–46 and accompanying text.
197
BAINBRIDGE, supra note 75, at 34 n. 19.
198
WILLIAMSON, supra note 179, at 74, 126–27 (opportunism and bounded rationality are
the central behavioral assumptions upon with the transaction cost approach is based).
190
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related to the concept of agency costs; one can view agency costs (which
includes a principal’s monitoring/enforcement costs) as a subset of
transaction costs.199
B. GOVERNMENT AS “FIRM”
It did not take long for the institutional economics literature to move to
governmental activities versus accomplishment of such tasks in the private
sector.200 The issue in this setting also boils down to minimizing transaction
costs: what are the comparative costs of making and enforcing both
governmental and private decisions? 201 For example, in the context of
administering social security benefits, monies paid to social security
recipients are not transaction costs, but the amounts spent by government
and recipients to confirm eligibility are transaction costs.202
Eventually, institutional/transaction cost economics reached tax
expenditures. In essence, the tax expenditure decision, which can also be
called an “integration decision,” is “solely a matter of institutional
design.”203 The choice between private parties and a governmental agency
as administrator depends on their relative efficiency in delivering service
and reducing the transaction costs faced by service recipients as consumers
in the marketplace; their relative efficiency in turn depends in part upon
their own transaction costs.204 For example, when comparing the relative
strengths of private employer-provided benefits (subsidized via the tax
code) or government-provided benefits, the question becomes whether a tax
expenditure is a relatively efficient means of achieving a public objective,
compared to a direct governmental expenditure. 205
Thus, we must avoid falling into a trap of automatically desiring the
removal of tax expenditures. A default position of always eschewing tax
expenditures is, in essence, an often one-sided transaction cost analysis that
199
BAINBRIDGE, supra note 75, at 34 n. 19.
Driesen & Ghosh, supra note 74, at 66, 84 (“[L]egal scholarship often involves
considerations of institutional choice, such as decisions about whether to employ
government or private decision-making to solve a problem.”).
201
Id.; see also David A. Super, Privatization, Policy Paralysis, and the Poor, 96 CALIF.
L. REV. 393, 410 (2008) (state coordination has long been recognized as a way to
overcome transaction costs).
202
Driesen & Ghosh, supra note 74, at 62.
203
Weisbach & Nussim, supra note 173, at 957. “Integration is a choice to take
advantage of the infrastructure of the tax system at the cost of less accuracy in program
design than would be achieved through a separate agency.” Id. at 982.
204
Laity, supra note 173, at 418 (focusing on the tax expenditure of employee benefits
that are tax-free to employees); see also Driesen & Ghosh, supra note 74, at 84
(institutional economics teaches that “comparative analysis must consider costs associated
with both institutional arrangements being compared; by including both government and
private costs as transaction costs” (e.g., costs of acquiring information to inform either
government or private decisions), “the transaction cost minimization rationale . . . involves
an even-handed comparison of costs as part of institutional analysis”).
205
Laity, supra note 173, at 424.
200
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“looks at the desirability of reducing private . . . or public transaction costs,
but rarely examines the tradeoff between the two.”206 “In the case of tax
expenditures, [taxpayers] administer the programs and absorb most of the
administrative costs,” while for direct expenditures, a government agency
“administers the program and bears the administrative costs.” 207 The
question is, how much different are these costs? Unlike comparing the cost
of direct government expenditure with expenditures by private firms (e.g.,
employers providing tax-free employee benefits), an institutional
economics analysis of the educator deduction weighs the costs (transaction
costs and otherwise) of the government purchasing these supplies versus
the costs of four million teachers separately buying the supplies.
C. WHAT IS “CHEAPER”: GOVERNMENT AS BUYER OR FOUR MILLION
TAXPAYERS AS BUYERS?
Removing tax expenditures is often difficult because the elimination of
a given Code provision “might be desirable only if a direct spending
program were substituted.”208 Thus, if the educator deduction is to be
repealed, this Article anticipates that it should effectively be substituted
with direct outlays by the Department of Education.
This section compares the cost of government directly funding
purchases of classroom materials and teachers directly purchasing them.
The first subsection argues that the purchase price of materials will be
lower if paid by government. The next subsection then compares
transaction costs, leading to a finding that such costs are also lower if
government pays for the educator materials.
However, before detailing the cost comparison, it is important to
consider the possibility of a qualitative benefit derived from teachers
(instead of government) selecting and buying the materials that will
outweigh the cost savings achieved by government paying for them. A
Hayekian view might argue in favor of educators deciding what works best
in the classroom, instead of mandates from a central education board or
school principal. 209 This aspect is arguably part of the intent of the educator
206
Driesen & Ghosh, supra note 74, at 106 (“the literature decries the ‘red tape’ involved
in administering social services, . . . but does not look as seriously at the public or private
transaction costs associated with a proposed alternative”); see also Laity, supra note 173,
at 425 (it is possible that the total cost to government of administering tax expenditures
may be less when considering the savings from not having to administer direct
expenditures through a specialized agency and the shift of administrative costs to the
private sector).
207
Laity, supra note 173, at 465.
208
Gravelle, supra note 22, at 393.
209
F.A. von Hayek, The Use of Knowledge in Society, 35 AM. ECON. REV. 519 (1945).
Hayek was a renowned opponent of centralized planning. He is known for the principle
that markets (price system) are the ideal mechanism for communicating information, and
the “most significant fact of this system is how little the individual participants need to
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deduction, as gleaned from comments of President Bush.210 However, even
if we have a teacher with unique approaches, using novel educator
materials in the classroom, it is still quite likely that such a teacher could
place the order for such materials through an agency special provider
program to save on the purchase price and transaction costs, as addressed
next.
1. Difference in Purchase Price
Every consumer knows the price of a product is cheaper when it is
bought in bulk.211 Warehouse chains such as Sam’s Club and Costco are
able to offer low prices on household goods to retail consumers because
consumers must buy in large quantities. A similar issue arises with educator
materials. Many school districts purchase materials in bulk from firms such
as Staples and Office Depot.212 Indeed, the Staples website has a portal for
federal government purchases213 and Office Depot offers an automatic 5%
discount for purchases made by schools. 214 Thus, it is very likely that a
school that pools its purchases of materials directly from a supplier will be
able to lower their purchase price.
know to be able to take the right action.” Id. at 526–27. See also Laity, supra note 173, at
439 (“tax expenditures promote individual choice and consumer sovereignty”).
210
President Bush Remarks, supra note 40 (“they need our support in empowering
teachers. And one of the important parts of the bill [the bill contained several education
initiatives, not just the educator deduction] that I signed divests power out of Washington,
gives teachers more flexibility in the classroom and more authority to the local districts.”)
211
Of course, in some cases, it is even cheaper to make a product yourself (see supra
note 183). However, government has long been recognized as not the ideal institution to
make its own goods. Williamson, supra note 77, at 319. Besides consumers’ experience in
learning to buy in bulk, many successful firms have purchasing departments dedicated to
minimize price of inputs. See, e.g., MICHIEL R. LENNDERS ET AL, PURCHASING AND
MATERIALS MANAGEMENT 314 (8th ed. 1985) (“A normal situation in purchasing occurs
when a price discount is offered if purchases are made in larger quantities”). However, it is
“preferable, of course, from the purchaser’s standpoint to take delivery in smaller
quantities but to still get the discount.” Id. at 315. Thus, such a buyer could take advantage
of “cumulative discounts,” which “instead of being computed on the size of the order
placed at any one time, it is based on the quantity purchased over a period of time.” Id. at
317.
212
See, e.g., HARFORD COUNTY (MARYLAND) PUBLIC SCHOOLS, INFORMATIONAL
REPORT, OFFICE SUPPLIES, TONER AND INK (Nov. 22, 2010), available at
http://www.hcps.org/Departments/businessServices/Purchasing/BoardLetters.aspx
(comparing costs of various store chains versus individual purchases and recommending
entering into a national sales contract).
213
Staples Advantage for the Federal Government, STAPLES.COM, http://www.staples4go
vernment.com/about.asp (last visited Dec. 22, 2011).
214
5% Back to School Programs, OFFICEDEPOT.COM, www.officedepot.com/special
Links.do?file=/promo/backtoschool/5percent.jsp (last visited Dec. 22, 2011). Office Depot
also discloses that it derives substantial revenue on sales to governmental agencies. 10-K
Year Ending Dec. 2010, at 10.
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Furthermore, one can imagine government bypassing the
“middleman”—directly purchasing materials from the firms that supply
Staples or Office Depot. For the previous three fiscal years, Staples’ and
Office Depot’s gross profit percentages were approximately 27% to
29%.215 It is reasonable to expect that if government contracted to buy
educator materials directly from Staples’ suppliers, the price could be far
less than the price Staples would charge because Staples as “middle man”
is being cut out. While it is possible that a large wholesale discount might
be realized if government buys directly from the wholesalers compared to
the prices Staples charged at the retail level to individual teachers, it is
likely that the full 27%–29% discount will not occur given the likelihood
that the wholesaler may incur (and pass along) marginal transaction costs
of its own that it previously avoided by selling through Staples.
Also, many states exempt purchases by federal and municipal
governmental agencies from sales tax. 216 Thus, an individual teacher incurs
sales tax that likely could have been avoided had the purchase been made
directly by government. If the average sales tax is about 6%, 217 and a
wholesale price reduction of possibly up to 29% can be obtained, it is
estimated that up to one third of the purchase price paid by individual
teachers could have been avoided if instead paid for in bulk by government.
Generally, government is not seen as adept as private parties in getting
the best price. 218 In other words, the tax expenditure approach generally
argues in favor of taxpayer control because the taxpayer can “pocket the
savings from cost control, but the agency cannot.”219 For example, the
teacher is paying the net cost of the materials (one minus their marginal tax
rate); thus, there is incentive for the teacher to push for the lowest price.
This is probably the only potential factor arguing in favor of purchases by
215
Staples 10-K for Year Ending Jan. 2011, at C-4; Office Depot 10-K Year Ending Dec.
2010, at 49. For example, Office Depot’s most recent year shows sales of $11.6 billion and
gross profit of $3.4 billion, or approximately 29% gross profit. When factoring in that both
Staples and Office Depot include occupancy costs in determining their gross profit, the
“pure” gross profit (selling price minus their purchase price) is actually higher.
216
E.g., CONN. GEN. STAT. § 12-412(1)(A) (2011). Connecticut also has implemented
procedures to facilitate the exemption documentation process. See, e.g., CONNECTICUT
DEPARTMENT OF REVENUE SERVICES, TAX E XEMPT PURCHASES BY CONNECTICUT STATE
AGENCIES AND MUNICIPALITIES (Dec. 9, 2010) available at www.ct.gov/drs/lib/drs/
publications/pubsps/2010/ps2010-7.pdf.
217
For current sales tax rates in the U.S., see SCOTT DRENKARD, TAX FOUNDATION,
RANKING STATE AND LOCAL SALES TAXES (Sept. 22, 2011), available at
http://www.taxfoundation.org/publications/show/27023.html. A handful of states do not
charge sales tax, leading to an average of approximately 6% in all 50 states.
218
Laity, supra note 173, at 470.
219
Id. The firm (taxpayer) must meet the needs of its shareholders, creditors, customers,
and suppliers. Although both kinds of organization (firm or government agency) are
subject to competition of some kind, the firm faces the stronger competition and the
possibility of liquidation; agencies do not have as “strong a corrective to unrealistic
subjective models of how the human environment functions.” Id.
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teachers, although it still appears that an individual teacher would be hard
pressed to beat the discounts (and sales tax exemption) allowed for bulk
purchases by government, as described above. However, even if the teacher
could beat the government’s price by scouring clearance racks, garage sales
or eBay, any such savings are outweighed by four million teachers’
differential transaction costs, as discussed next.
2. Transaction Cost Comparison
As noted above, there are several types of transaction costs. The types
that are involved in the institutional analysis comparing transaction costs of
government paying for classroom materials versus four million teachers
buying materials include functional costs (i.e., get-together costs, decision
and execution costs, and information costs) and monitoring costs related to
protecting against opportunism (e.g., a taxpayer falsely claiming an
educator deduction). There are five major reasons why the total transaction
costs are far higher when four million teachers purchase the materials and
then seek subsidy via the educator deduction.
/First, the educator deduction fails to take advantage of already in-place
infrastructure for making educator materials purchases. This infrastructure
is able to dramatically reduce per unit functional transaction costs due to its
giant scale relative to the tiny purchase of any one teacher. Generally, the
“use of tax expenditures avoids the creation of a public bureaucracy” and,
thus, from “government’s point of view, tax expenditures are largely selfexecuting” because they are “administered by the private sector.”220
However, this benefit is not present in the case of educator materials,
because government already has bureaucracy, including purchasing
expertise, in place to fund education including buying these types of
materials. 221
Second, the mundane cumulative transaction costs of effecting
transactions to purchase are clearly far less if made by government instead
of four million teachers. The teacher has to travel to and from the store (or
if ordering on the internet, pay shipping costs and confirm delivery),
determine prices, and make payments. Furthermore, because the teacher is
subsidized by the tax code, there are also burdens of record keeping. As
James Payne generally points out, “when the [taxpayer] asks the [seller] for
a receipt, the compliance burden includes not only his time in waiting for
the receipt, but the clerk’s time in supplying it, as well as the cost of
220
Id. at 439–40.
Applying the institutional economics “analytical framework to privatization debates is
logical since state coordination long has been recognized as a means of overcoming
transaction costs.” Super, supra note 201, at 410. Where the “government already has the
necessary infrastructure in place, and where private parties have few other present or
future uses for that kind of infrastructure, paying to have the wheel reinvented rarely
makes sense.” Id. at 422.
221
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electricity needed to run the printing calculator, depreciation on the
calculator, even the cost of the paper on which the receipt is printed.” 222
Third, for teachers who engage a paid preparer, they must pay the
preparer some amount extra to account for the deduction. This fee may be
as much as $30 (based on one large tax preparation firm’s price menu). 223
This fee is therefore likely to consume half the tax savings. For teachers
who decide to learn the tax rules themselves, they will likely struggle to
confirm that they are an eligible educator, they work for an eligible school,
and that the expenditures are eligible expenses. On the other hand, these
eligibility factors are confirmed easily at the local school agency level as it
approves purchases of materials.
Fourth, opportunism and necessary monitoring costs argue in favor of
government direct payment. Taxpayers are tempted to cheat by claiming an
educator deduction not actually incurred or permissible. As noted earlier,
the data on the average educator deduction shows it is suspiciously close to
the maximum of $250, perhaps suggesting that many taxpayers list the
maximum as a matter of course or perceived entitlement.224 Furthermore,
the IRS is “ill-equipped to administer” and monitor/enforce the educator
deduction tax expenditure compared to a “specialized agency.” 225 For
example, assume the IRS audits a teacher’s claim of the educator
deduction. The audit can easily confirm whether the taxpayer indeed
incurred the claimed expenditure for the relevant materials (assuming the
teacher maintained receipts). But it is difficult for the auditor to confirm
whether the taxpayer was an eligible employee, that he worked for an
eligible institution, and that the materials represented eligible expenses (a
task that may be difficult to accomplish because the materials likely are no
longer in the teacher’s or school’s possession by the time of the audit). 226
Again, these eligibility factors are confirmed easily at the local school
agency level as it approves purchases of materials.
Fifth, another aspect of opportunism results because taxpayers in higher
tax brackets are more motivated to incur the cost than others. In other
222
PAYNE, supra note 80, at 16–17. Notice how Payne points to added costs outside of
government and teacher; even the supplier has added transaction costs by dealing with four
million teachers as opposed to a few governmental agencies.
223
H&R Block, Estimate Your Return, www.hrblock.com/taxes/doing_my_taxes/price
_estimator.html (last visited Dec. 22, 2011). H&R Block charges $29.95 for Form 2106,
which includes various unreimbursed employee expenses, which is then transferred to
Schedule A’s miscellaneous deduction section. Form 2106 is more detailed than Form
1040 line 23’s educator deduction. Thus, it is possible that the fee is different. It is also
possible the marginal fee for the educator deduction is zero if over $250 was spent, as
the preparer reports $250 on line 23 and the remainder on Form 2106.
224
See supra notes 167–68 and accompanying text.
225
Laity, supra note 173, at 428.
226
Furthermore, monitoring and enforcement costs extend beyond IRS resources. Some
cases may even consume court time in assessing taxpayers’ claim of the educator
deduction. See cases described supra note 161–62 and accompanying text.
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words, “tax expenditures are regressive in the sense that the benefits from
tax expenditures go disproportionately to higher-income taxpayers . . . ;
those taxpayers are subject to higher marginal rates of tax and thus gain
greater tax savings from tax expenditures than do taxpayers at lower
income levels.”227 A teacher with a wealthy spouse can afford to buy more
expensive materials than a teacher with a non-working spouse (perhaps
with a zero marginal tax rate). IRS data clearly shows a pattern that the
higher the AGI, the higher the average educator deduction. 228 Accordingly,
a more egalitarian approach to introducing teacher-desired materials to the
classroom exists if funded by government, not via the tax code.
V. RECOMMENDATIONS
At first blush, we desire the removal of all complexity from the tax law.
However, tax complexity and tax simplicity are “neither bad nor good.”229
“In evaluating the Code and any proposed tax reform, more attention
should focus on promoting the core values of equity and efficiency.” 230
This Article agrees. Instead of seeking to remove all complexity, this
Article argues that immaterial tax law provisions be immediately identified
and removed. This would serve as an incremental step towards
simplification, going in the opposite direction of the decades of
incrementalism that produced the current complex law. 231 Furthermore, any
future enactments under the Code (or even under a replacement regime,
such as a consumption tax232) should likewise avoid adding any immaterial
provisions, including provisions that appear material when enacted but will
at some point become immaterial (because of, for example, inflation or
obsolescence of the particular transaction).
227
Laity, supra note 173, at 424, 426. While Laity notes this as violating principles of
vertical equity, it also distorts purchase decisions.
228
For example, in 2008, the average educator deduction taken on tax returns with AGI
between $100,000 and $200,000 was $273, while for those with AGI between $25,000 and
$30,000 was $217. See I.R.S., supra note 30, TABLE 1.4, ALL RETURNS: SOURCES OF
INCOME, ADJUSTMENTS, AND TAX ITEMS, BY SIZE OF ADJUSTED GROSS INCOME (2002–
2008).
229
Donaldson, supra note 72, at 745. The “current political paradigm denouncing the
Code as ‘too complex’ and lauding reforms that will ‘simplify’ the tax laws is misguided.”
Id.
230
Id. (“Crusades to simplify the Code should be suspicious because simplicity is not
always the best way to advance the core values.”).
231
See WITTE, supra notes 18–19 and accompanying text for discussion of
incrementalism.
232
Even if we replaced our income tax law with a new approach, one can imagine that
new regime would slowly inch towards complexity. See, e.g., Paul, supra note 84, at 156
(the same sources of complexity that apply to our current income tax would also contribute
to the complexity of a consumption tax).
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Congress should treat immaterial provisions as “deadwood” and
remove them. 233 Clearly, the $100 floor should be repealed, as should the
educator deduction (or not further extended). Alternatively, if there is a
substantive reason to keep the qualitative aspects of the currently
immaterial provision, then the dollar amount should be increased
accordingly, as was done for the $100 floor, albeit for one year only in
2009, when it was increased to $500.234
If the educator deduction is repealed, the federal government could
increase the amount it currently provides local government for education.
In 2008, it appropriated $38 billion for education for elementary and
secondary schools. 235 Based on the estimates presented in Part II.B., this
amount could be increased by approximately $200 million, the tax savings
annually enjoyed by the teachers taking the educator deduction. 236 These
local agencies would then add the $200 million to other funding (e.g., their
own state legislature’s funding) and use their current bureaucratic
infrastructure to pay for materials. This line of thinking is similar to
Professor Brannon’s argument that, in the name of simplification, the tax
expenditure implied by the tax deductibility of local sales tax is better
handled by the federal government cutting a check directly to the localities
for the tax benefit taxpayers would have had from deducting sales taxes and
then having the locality lower the sales tax rate.237
For other immaterial tax rules that operate as tax expenditures,
Congress should perform an institutional economic analysis similar to that
done in Part IV. It may well be that that some of these expenditures are,
unlike the clear case of the educator deduction, more easily handled
through the tax code instead of through a government agency. For example,
child care expenses should not be subsidized directly by a new agency
because it does not make sense for the government, “from a purely
administrative point of view . . . [,] to set up a separate system” for
processing child care expense applications and issuing checks. 238 Instead,
233
See OVERALL STATE, supra note 132, Volume II, at 88, 579–93 (summarizing
deadwood to be considered for removal from the tax law). Deadwood are provisions in the
tax law that address items that are no longer in the law. For example, one Code section
might cross reference another Code section that no longer exists.
234
See supra note 23.
235
Education Department Budget History Table, www2.ed.gov/about/overview/budget/
history/index.html (last visited Aug. 22, 2011).
236
The $200 million estimate may need to be slightly reduced to the extent teachers are
able to deduct on Schedule A what they would have deducted on line 23’s educator
deduction. It is difficult to do so due to the 2% of AGI floor (assuming they even itemize)
and possible AMT disallowance, as discussed supra notes 37–38 and accompanying text,
and text paragraph including supra note 165. IRS data also suggests how infrequent it is
that a teacher could deduct on Schedule A. See supra note 163.
237
Brannon, supra note 10, at 199.
238
SLEMROD & BAKIJA, supra note 102, at 169–70.
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the IRS can more easily manage the process of subsidizing child care
expenses via the dependent care credit.239
Similar institutional economics analysis can be made for items not
normally thought of as tax expenditures. Social security receipts are
included in AGI based on the taxpayer’s modified AGI. 240 For upper
middle class and wealthy taxpayers, the calculation is quite easy: 85% is
included in AGI; however, for others the calculation is extremely
complicated (and often immaterial) due to its phase-in calculations and
alternative AGI floors.241 It is likely the rare senior citizen who is able to
handle this calculation on his own. In essence, § 86 is a form of meanstesting. If the Social Security Administration has access to tax return data
(even if just modified AGI), it seems more efficient to have SSA
implement the means-testing by directly reducing the recipients’ social
security payments.
An important step in removing any inefficient tax expenditures, even if
immaterial (such as the educator deduction), requires careful consideration
of the affected special interests. As noted by Slemrod and Bakija, “Once
adopted, tax preferences develop strong lobbies that fight to retain them—
for instance, by making campaign contributions to like-minded politicians.
In contrast, no well-organized constituency opposes the complexity that
these preferences generate.”242
In the case of the educator deduction, government will have to be very
clear in explaining to teachers (and their representatives, such as the
National Education Association) that they will not lose the approximately
$1 a week because government will fund the expenditure directly as
described above. If there is a teacher who continues to incur costs beyond
the amount, they will be permitted, as before, to seek a deduction on their
Schedule A (miscellaneous deductions subject to 2%-of-AGI floor).
Finally, Congress should consider amending the Paperwork Reduction
Act, which has an express purpose to minimize the paperwork burden
resulting from the collection of information by or for the Federal
Government.243 Unfortunately, the PRA reflects Congress’s focus on
agencies’ resistance to change but not its own complicity in complicating
the law. In other words, “the IRS is not to blame for the rise in the
paperwork.”244 The problem is “Congress is adding to the tax laws’
239
Id.
I.R.C. § 86 (2006).
241
Id. (the so-called “50% vs. 85% rules”).
242
SLEMROD & BAKIJA, supra note 102, at 171.
243
See supra note 14 and accompanying text.
244
Keating, supra note 138, at 10 (noting that the Government Accountability
Office praised the IRS for being one of only two agencies that had implemented a
procedure that reduced paperwork).
240
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complexity faster than the IRS can simplify its forms.” 245 Immaterial tax
law provisions violate the spirit of the PRA. 246 President Obama has also
repeated the theme of simplification, stating that “[w]e’re also getting rid of
absurd and unnecessary paperwork requirements that waste time and
money. We’re looking . . . to make sure we avoid excessive, inconsistent
and redundant regulation.”247 Obama has also issued executive orders
seeking to move this forward.248 Accordingly, Congress should consider
amending the PRA to require two items. First, any laws enacted by
Congress must first consider immateriality thresholds. Second, for
proposed tax legislation that operates as a tax expenditure, an institutional
economics analysis should first be completed to confirm that it is the most
efficient avenue to accomplish the goal, after factoring in all parties’
transaction and other costs.
CONCLUSION
This Article adds to a long stream of academic papers, books and
political rhetoric that lament our tax law’s complexity and offer suggestions
to improve it, or in some arguments, seek to replace it with other
approaches. However, in the politics of the moment, it appears difficult to
effect dramatic change in the Code. This Article argues that a more
manageable and pragmatic approach to improving the tax law is to reverse
its complexity through an incrementalist approach focused on removing
immaterial provisions.
This Article demonstrates that the tax code contains many immaterial
tax law provisions. It provides evidence of how two immaterial tax law
provisions apply to millions of taxpayers yet have trivial individual and
overall tax effects. Both the $100 floor on personal casualty and theft
deductions and the up-to-$250 educator deduction add unnecessary
complexity and thus inflate transaction costs for the government and
taxpayer. Furthermore, an institutional economics analysis reveals that the
educator deduction, which acts as a tax expenditure, is an ideal candidate
for removal from the tax code—to instead be directly expended by
government. The direct purchase price of the materials, as well as related
transaction costs, will be far lower if the educator materials are paid for by
245
Id. at 10–11. Paperwork burdens are not the result of IRS bureaucrats mindlessly
dreaming up new forms and regulations.”
246
These provisions also conflict with the purpose of the Regulatory Right-to-Know Act
of 1999 (31 U.S.C. § 1105 (2000)), the purposes of which are to “promote the public rightto-know about the costs and benefits of federal regulatory programs and rules, . . . increase
government accountability . . . [, and] improve the quality of federal regulatory programs
and rules . . . .
247
Barack Obama, Op-Ed, Toward a 21st-Century Regulatory System, WALL ST. J., Jan.
18, 2011, at A17.
248
See Exec. Order No. 13579, Regulation and Independent Regulatory Agencies, July
11, 2011, 76 Fed. Reg. 41587; Executive Order No. 13563, Improving Regulation and
Regulatory Review, Jan. 18, 2011, 76 Fed. Reg. 3821.
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government, not separately by four million teachers. This Article offers
other examples of immaterial provisions and invites Congress to perform a
systematic search for others to remove.
The reader might argue that this paper, with its focus on the trivial,
immaterial, and tedious, is itself an exercise in tedium. However, the first
steps in any recovery (be it getting back on one’s diet, reducing federal
debt, or reducing tax complexity) is to first turn the tide. Baby steps in the
direction of simplification will help lead to instilled confidence in the tax
system and ideally create inertia to take bolder, larger steps towards
simplification.