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April 30, 2012

Waste and Fraud: The Consequences of an Unmanageable Tax Code

By now, everyone has heard our rants about some of the consequences of a bloated government. We've discussed the increasing personnel and overhead costs associated with regulating a massive body of laws. We've also discussed the losses in economic freedom associated with those regulations/laws.

Now, the dynamics of tax collection and refunding are being affected by the complicated tax code and the massive workloads it is creating.  These complications affect both the taxpayer and the government's ability to adequately collect revenue.

The newest trend has been identity theft.  This is where somebody steals your identity, files your taxes for you, and then collects the refund.  It is a rapidly growing practice that the IRS hasn't been able to quantify or control.  Today's video at the bottom of the article deals with the topic of identity theft in tax fraud.

The other problem, as seen on an article published to the CNBC website a few weeks ago, is the inability to collect revenue.  The IRS collects $2.4 trillion in revenues per year.  The organization estimates that it loses a stunning $385 billion to waste and fraud per year or 16.4% of total revenue.  For every dollar the IRS collects, it loses more than 16 cents in legitimate, collectible revenue.

To put these losses into perspective, the average operating margin for an S&P 500 company over the last 5 years is 15%, according to Reuters.  If we apply the IRS revenue capabilities to that model, we get an operating loss of more than 1%.  The 'average' S&P 500 company would eventually be insolvent if their collections methods were as efficient as the IRS.  In broader terms, over half of these companies would not survive.

Clearly the IRS doesn't want to forfeit this money, but it's hard to collect when the filers, accountants, IRS auditors, administration,  and basically the entire stakeholder model has an incomplete understanding of the tax code.  The data suggests that a simpler tax code would actually increase revenues, even if marginal tax rates were 10% lower than their previous levels.

Applying the same chart model as we did with the Buffett tax, take a look at the waste proportion of IRS collections.  Does correcting this improve the deficit over the Buffett tax?

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