The Tax Law System is Only Incomprehensible to Some

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Cooperative communication between the Internal Revenue Service and taxpayers would improve the comprehensibility of taxation.

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Journalists often remark that income tax rules are incomprehensible and that taxpayers cannot understand the law or the explanatory guidance created by the Internal Revenue Service (IRS). In her recent book with Will Walker, Incomprehensible!, Wendy Wagner develops a rubric to evaluate the process by which the law and agency action become incomprehensible.

Unfortunately, applying that rubric to the federal tax system is difficult because of the system’s multiple speakers and audiences. Attempting to fit this system within the rubric, however, highlights how federal tax rules’ incomprehensibility depends upon how one defines the relevant audience, a task the government has yet to undertake.

The first step in Wagner’s rubric—identifying a speaker and an audience—is currently impossible in the tax system. As Wagner recognizes, there can be many different audiences for government information, but her rubric depends on defining an “average” member of the audience. Unfortunately, the tax system comprises a many-party conversation among Congress, the IRS, and taxpayers. Within the government, Congress and the IRS have different, sometimes contradictory, roles. Congress may try to hide targeted benefits or tax increases in complicated rules. IRS officials must administer these rules and collect taxes, demanding they give plain meaning to the rules as written.

Isolating the speaker and audience as between the government and taxpayers is also difficult since taxation is an iterative process. The IRS facilitates tax filings by creating instructions and issuing guidance. Taxpayers then file their returns, to which the IRS responds with audits. For simplification, the tax system may be bifurcated into the government’s production of guidance and taxpayers’ production of returns, but the interactions between the two poses opportunities for incomprehensibility worthy of further study.

Wagner’s second step is to evaluate the audience’s ability to process information. When the IRS produces guidance, it must reach both unsophisticated and sophisticated taxpayers. Unsophisticated taxpayers have difficulty comprehending the law, while sophisticated taxpayers choose whether to be rule followers or rule benders. Simplifying or reducing tax guidance to aid unsophisticated taxpayers creates opportunities for exploitation by sophisticated ones.

For example, the target audience for complicated international tax rules consists of sophisticated international businesses. Smaller businesses might be caught by the rules, but Congress could justify the system as a response to rule benders who would use a simple tax regime to their own advantage. It would be difficult, if not impossible, to create rules that police the behavior of sophisticated rule benders in ways that would be comprehensible to the unsophisticated, and trying to explain existing rules in simple terms would be unlikely to convey their full meaning accurately.

When the IRS is the audience for tax returns—which can reach hundreds of pages in length—IRS agents must figure out complex transactions. Much like unsophisticated taxpayers, the IRS, with its budget cuts and expanding role administering social welfare programs, is often a relatively weak audience at the mercy of powerful speakers. Sophisticated taxpayers may not recognize their power, but with long returns to audit, complicated transactions to unravel, and skillful lawyers to oppose, these taxpayers may commandeer the IRS’s time and energy, derailing other agency objectives.

Wagner’s third step requires us to evaluate the speaker’s incentives, which are often flawed in the tax domain. Taxpayers as speakers have incentives to reduce their taxes, with some hiding the ball to reduce the chance that the IRS detects their evasion. All taxpayers risk penalties if they fail to pay their full taxes. But less than 1 percent of returns are audited and, even when they are, taxpayers do not face penalties for incomprehensible tax returns. Instead, the IRS and courts bear the cost of deciphering complicated returns.

The IRS, as a speaker, must comply with the Taxpayer Bill of Rights that provides taxpayers the right to be informed, but that right cannot be privately enforced. Taxpayers cannot demand information. Ignoring any notion that information must be usable by its audience, the IRS retains the right to contest a taxpayer’s understanding of guidance, no matter how incomprehensible that guidance might be. Perhaps surprisingly, even when taxpayers devote resources to understand IRS guidance, in many instances they may not rely on it in audit or in court.

Wagner’s final step asks us to compare the speaker’s incentives with the audience’s ability to understand the information that is presented. This raises again the thorny issue of who is the audience: the IRS or taxpayers? Sophisticated taxpayers have an advantage over the IRS, with the incentive to understand the law and challenge its limits. Unsophisticated taxpayers often have an incentive to complain about the law and relatively little to fear from failing to understand it. The IRS is likely to be denigrated for its guidance and auditing regardless of its efforts at comprehensibility.

Given what appear to be everyone’s weak incentives to provide comprehensibility, Wagner’s analysis helps show how the federal tax system has important lessons to learn. This system is not inherently incomprehensible. Taxpayers need to be encouraged to convey information to the IRS in a comprehensible form, and the IRS needs to figure out how to differentiate guidance for sophisticated and unsophisticated taxpayers. For both speakers and audience members, cooperative communication may be collectively valued, but the tax system’s perceived gamesmanship and everyone’s pursuit of their individual interests will make comprehensibility hard to develop.

If the IRS is to communicate clearly with taxpayers, and vice versa, it will take reconciling and differentiating audiences that have conflicting abilities to comprehend the barely comprehensible. The task is not impossible, but it will remain an ongoing challenge.


Stephanie Hunter McMahon

Stephanie Hunter McMahon is a professor of law at the University of Cincinnati College of Law.

This essay is part of a six-part series, entitled Creating Incentives for Regulatory Comprehensibility.