Home > Fiscal Policy, Taxation > The Lesson from the IRS Scandal

The Lesson from the IRS Scandal

The IRS scandal that has been dominating the media’s political coverage contains a lesson about economic policy that has not received much attention. That lesson is this; the scandal is the best argument that I know supporting an overhaul of the tax code to simplify it and make the tax rules as clear as they can be.

Most economists subscribe to the notion that households and firms can best maintain their self-interest when the policy environment is clear. This is a point emphasized in the rational expectations literature but it is a very intuitive notion. When the public knows the tax rules of the game, they can make better economic decisions because the public will know how its decisions will impact their tax liabilities. The less clear are the rules, the more resources we must devote to hiring attorneys and accountants who help us navigate a complex regulatory and tax environment. This complexity does not help us create wealth and improve living standards.

The tax code that we now have is riddled with situations that require interpretation by the IRS and, the more situations that require interpretation, the greater the potential for abuse. I suspect that this ambiguity is just fine for many politicians who are willing to manipulate the IRS for political advantage (here is a link to a news story describing the letters sent to the IRS by eight Democrats). But I think the public realizes what a nightmare it can be to deal with an IRS audit (a Romney supporter spent $80,000 defending himself in an IRS audit and ultimately paid no additional tax) so it is not surprising that polls show widespread public disapproval of this manipulation of the IRS.

If the IRS scandal has any long-run benefit, it will give us a better chance for a tax code overhaul which will vastly simplify it. I am not optimistic but hope springs eternal.

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Categories: Fiscal Policy, Taxation

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Economics One

A blog by John B. Taylor

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