Overcoming Forosophobia

Tax achin' without participation

Writing about taxes for my first issue is probably not a great way to maintain subscribers for my second, but please stick with me – next week will be something light and easy. I'm starting this newsletter in part to stay in better contact with people, but I also want to improve my ability to articulate my ideas, so I'd greatly appreciate your feedback.

The United States has a famously complex, obscure, and difficult-to-engage-with tax code. Taxes are withheld from our paychecks throughout the year, and our employers, banks, and mortgage providers all provide documentation on our income and expenses directly to the Internal Revenue Service – and then, by mid-April each year, we must file a copy of that same documentation along with Form 1040 and hope that the tax calculations we've performed are similar enough to what the IRS expects that we get a refund quickly.

Nevertheless, I look forward to doing my taxes every year. Some of this is sentimental – I remember my mom sitting all day at our dining room table in her jammies and robe while doing our taxes when I was a kid, and “doing my own taxes” always felt like a Very Adult Thing To Be Doing. Another part is more like engineering: it’s like taking apart a complicated machine to understand why it works - and then, occasionally, finding some money hidden inside. But for me, it’s also a matter of civics: I live in this country, and this country has an income tax that applies to me, so I should understand how it works and how it impacts me.

John Brooks devotes an entire chapter of his 1969 book "Business Adventures" to a discussion of “The Federal Income Tax”. He writes: "If the single most important law now on the statute books of the United States is the income-tax law, it would follow that we must have the income-tax law we deserve...the income-tax law, that is, should be to some extent a national mirror." Complaints about taxation certainly do mirror challenges we see elsewhere in society: about "regulatory capture" by tax preparation companies who prefer a complex tax code; about the "dark patterns" in software design that trick people into paying for tax preparation that they're often entitled to have done for free; about the way that the tax system has been repurposed to replace other types of social aid; and of course, about the ways that the complexity inevitably favors those with the wealth to pay for novel business structures and dedicated tax advice. On top of all this, I also suggest that this “tax industrial complex” also has a more pathological impact: it deprives people of the ability to understand what taxes they actually pay (and why) and to change their behavior in a way that would save them money.

This is a good time for me to make something clear: I am not a tax professional, nor have I received any form of financial certification or registration. Nothing I'll be discussing today is or should be considered as tax advice or financial advice. If you know better and think I'm wrong, please tell me.

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There is a populist elegance to the fact that all American taxpayers file Form 1040 – just like we all end up going to the DMV when our license expires, or waiting in the same big room when we’re called up for Jury Duty. Because Form 1040 comes with an instruction manual, you can work your way down the form, line by line, and figure out more-or-less what's going on. This turns out to be an effective myth busting tactic as well: have you ever been told that bonuses are taxed differently than salary? Have you ever worried that a higher salary will actually cost you money by pushing you into a higher income tax bracket? Both of these ideas are widely believed, though neither is true, and it’s easy to see that this is the case when reviewing Form 1040. It is also surprisingly straightforward to calculate one's effective tax rate - but few take the time to do it, because most people don’t take the time to review the forms.

It’s true, there are some parts that get a little complicated – but tax returns are complicated because the tax code is complicated, and much of this complexity comes in the form of carveouts for preferred behaviors such as installing solar panels, or installing a high efficiency furnace, or operating a certain type of business, or adopting a child, or being an educator or a performing artist, or a huge number of others. Tax reform always sounds compelling until people realize it means taking away tax breaks for teachers or eliminating interest deductions for homeowners - so rather than making the tax code less complicated, recent tax changes have focused instead on making tax returns seem more "simple". The most recent tax change in 2017 prioritized "being able to file taxes on a postcard" - so it shrunk Form 1040 to a double-sided half page of paper, and then moved all the lines that wouldn't fit onto six additional forms you might need to file. Simple, right?

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I had an unnerving realization recently - one that led to me writing this first newsletter issue about taxes rather than something fun and electronic: I didn’t enjoy filing my taxes this year.

It took me a few days to realize that it was because of the tax prep software I had to use. [1] The technical exploration of filing my return had had transformed into a wicked domain where I had no idea how my inputs mapped to results. The entire process was gamified around “maximizing my refund”, but with very little context for why a particular choice did or did not reduce my taxes. It’s analogous to the neighborhood kid who comes by to fix your computer and also offers to “optimize your registry” - but you have no idea what they actually did or whether it was a good thing to do.

Even worse, in at least half a dozen places, the software could have offered me constructive advice about how to actually save money on the next year's taxes by changing my HSA withholding, or donating appreciated stock instead of cash, or by contributing more to a retirement plan - behaviors I’m already familiar with, that the tax code is actually written to incentivize, and that a competent tax advisor would be able to recommend to you. They could even have made some suggestions about how to change my tax withholding so that the taxes withheld each paycheck would more closely match what I’d actually owe next April - but then again, that would make the "refund maximizer” a lot less compelling.

Worst of all, there were a couple things on my W2 that indicated problems that could have cost me a lot of money in wasted taxes or retirement distribution penalties. I knew about these issues because I’d already had to make calls to fix them, but there was no way to know that from my W2. This is exactly the sort of thing that tax software is well-positioned to warn about, but doesn’t. But on the other hand, they’re perfectly happy to encourage me to pay extra to assuage irrational fears: preemptively upgrading to a Premium edition of the software in case I might need to file any “complicated” extra forms, or paying $50 for an “audit protection” service.

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I wish I could be optimistic that this will get remedied, but there hasn't been a major overhaul of the US Tax Code since 1986, and much of the national energy seems to be going toward things like wealth taxes or national sales taxes. In "Business Adventures", Brooks quotes IRS commissioner Caplin as saying "There's a mystic quality about our tax system. No matter how bad it may be from the technical standpoint, it has a vitality because of the very high level of compliance...I'm optimistic that fifty years from now we'll have a pretty good tax." Fifty years later, our tax code doesn’t look all that different, but I’m also not even sure we still have that same “level of compliance” - for example, the Build Back Better Act is projected to be funded in part simply by more thoroughly enforcing tax laws on high-income earners. And the bipartisan "Taxpayer First" act of 2019 very nearly included a permanent ban on the IRS offering free tax filing, and was sponsored by several legislators I respect and admire.

I do have two small hopes. When Intuit purchased Credit Karma, they were forced to sell off the free "Credit Karma Tax" product to Square. It’s the one option I’m aware of for e-filing both state and federal tax returns for free, and their willingness to step on the toes of others in the tax prep industry gives hope that they might be willing to also offer a higher quality tax service as well.

A second hope is more of a dream - but so much of the magic of today's World Wide Web was built off of open API endpoints and free software. Perhaps someday the IRS will offer something similar for tax filing - an IRS managed endpoint that community-supported free software packages could use to submit tax returns.

Until then, we'll always have Form 1040.

[1] - There are certain Georgia tax credits I’m eligible for that I can only claim when filing electronically – but there is no way to simply e-file a state tax return in Georgia: it must be done through an approved software provider, and these providers won't allow me to file a state return without also filing my federal return. And none of these give me the option to “simply fill out the form”. I’ve now used Tax Slayer, TaxAct, and TurboTax, with no substantially different results between the three.