When Jerome Rodder of Los Altos, Calif., got the notice that his tax return was up for audit, he knew the routine. Two previous examinations had prepared the 67-year-old inventor and real-estate investor for the grinding drill. But after investing 45 hours of his own time and $4,000 in accountant's fees, Rodder balked at an IRS form demanding that he document such personal spending as restaurant and laundry bills. "I'm not a tax protester," grouses Rodder, who paid $6,000--about 10% of his annual tax bill--to settle. "But they had better never come near me with that form again. There must be a lot of people as angry as me."
There are. And they're being heard. As Congress crusades to overhaul the tax system, it's aiming heavy artillery at the beleaguered agency that collects the taxes--the Internal Revenue Service. "We need a tax system that doesn't require a government agency poking into the private affairs of every American citizen," declares Representative Bill Archer (R-Tex.), chairman of the tax-writing House Ways & Means Committee. Archer wants to replace the income tax with a national sales tax collected by the states--eliminating the IRS.
Dream on. The tax collector will always be with us. But congressional proposals to tax consumption instead of income could radically curb the IRS's role in American life. Such reform plans could wipe out many of the most vexing and audit-prone portions of the tax code: itemized deductions, personal taxes on interest income, dividends, capital gains, and the complicated rules businesses face on depreciation and pensions.
Under a flat-tax proposal championed by House Majority Leader Richard Armey (R-Tex.), for instance, "you not only can fit your tax return on a postcard--you can practically put the whole tax code on one page," says economist Bruce Bartlett of the National Center for Policy Analysis.
As the forms shrink, so would the IRS's 112,000-strong workforce and its $7.5 billion budget. A simpler code would require fewer lawyers to write regulations, fewer phone operators to answer taxpayer questions, and fewer clerks to handle returns. Taxpayers would save money, too: Tax Foundation analyst Arthur Hall estimates that Armey's plan would cut individuals' and businesses' tax-compliance costs from $140 billion a year to $8.4 billion.
The IRS may have only itself to blame for being such a fat political target. In five of the past six federal budgets, lawmakers boosted allocations to the IRS for compliance, figuring the investment would yield a profit. But the increase in spending hasn't resulted in the promised revenue. The audit rate continues to fall--only 1.08% of individual returns are examined--and tax debts on the IRS's books grew by 80%, to $156 billion, from 1990 to 1994.
IRS officials vow to do better. Commissioner Margaret M. Richardson says 5,000 new employees, hired with $405 million in extra 1995 funding, are starting to reap a promised $9 billion in added collections. A $23 billion program to replace a 1960s-vintage computer system will improve monitoring of taxpayers' accounts. And electronic filing could sharply reduce IRS error rates: Almost 5 million users of the simple 1040EZ form will be able to "telefile" from a TouchTone phone next spring, while millions more will report their taxes via personal computer. "We're moving to a system that's very different from the way we did business even a few years ago," Richardson says.
First, however, taxpayers will see the unfriendly face of the IRS in the form of stepped-up auditing. This fall, the service rolls out its Taxpayer Compliance Measurement Program audits, its first compliance audits since 1988. Under the program, the IRS will pick 153,000 individual and business tax returns at random for line-by-line examination. The resulting data should guide the IRS toward the most likely areas for cheating.
Taxpayers who endure the harrowing experience of justifying virtually every figure on their 1040s will become Exhibit A for Archer, Armey, and other GOP reformers building support for tax reform by tapping into deep public resentment against the IRS. Polls of the 600,000 members of the National Federation of Independent Business name the IRS their most hated agency. When President Clinton bragged about his efforts to cut red tape, delegates at a June White House Conference on Small Business heckled him with shouts of "IRS! IRS!"
The anger is based on a growing belief among Americans that Washington is too intrusive. In one new IRS tactic, auditors are trained to rely more on "economic reality"--studying a taxpayer's home, vacation, entertainment, and even health spending--for evidence of unreported income. "People are aghast that a government agency will be looking into your underwear drawer and asking your neighbors to monitor your lifestyle," says Stephen Moore, director of fiscal studies at the libertarian Cato Institute.
Case in point: the Green Glen Bed & Breakfast in East Aurora, N.Y. When an IRS auditor arrived this spring to examine the 1993 books at the inn, owners Edwin and Martha Collins answered every query with meticulous records. Yet the examiner insisted the Collinses had underpaid by $540, claiming they'd spent too much on food for their guests' laundry and cleaning services. "Is the tax service going to be telling us what we can serve, how we should clean, and what grade of detergent we should use?" asks Ed Collins. "The intrusiveness is just mind-boggling." The audit is still unsettled.
Some IRS critics maintain that it's the tax code, not the agency, that's the real problem. "The current tax system is so complex that it's very difficult for the IRS to administer taxes effectively," says Shirley D. Peterson, president of Hood College and a former IRS commissioner. Peterson wants to start over with a new code, which she hopes to help write as a member of a GOP panel chaired by former Housing & Urban Development Secretary Jack Kemp.
Still, it's not at all clear that a truly simple code could survive Washington's legislative meat grinder. "People talk about the importance of simplicity--until it hits them in the wallet," says former IRS Commissioner Lawrence B. Gibbs. Once Congress starts debating reform in earnest in 1997, wage earners will object to plans that let investors off scot-free, while homeowners, charities, and local governments will demand relief from the pain of losing deductions.
Any new code, of course, could well end up as convoluted as the current tax law. But tax revolutionaries know they have a powerful rallying cry--"Death to the IRS!"--and they plan to milk it for all it's worth.
PORTRAIT OF A BUREAUCRACY
More complicated rules, more penalties for taxpayers, and plenty of uncollected taxes
-- Page count for Internal Revenue Code law and regulations: 17,000
-- New tax forms added since 1985: 100
-- Growth in number of penalties assessed, 1980-93: 68%
-- Number of notices and exam letters sent each year: 100 MILLION
-- Number of taxpayers receiving penalty notices in 1994: 33 MILLION
-- Taxpayer penalties levied in error and refunded in 1993: $5 BILLION
-- Increase in IRS enforcement budget since 1991: 29.1%
-- Odds of getting through to IRS telephone assistance: 1 IN 4
-- Error rate on IRS telephone assistance: 11%
-- Error rate in IRS account notices: 48%
-- Uncollected taxes in 1992: $127 BILLION