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COMPLEXITY AND THE TAX GAP: 

MAKING TAX COMPLIANCE EASIER 

AND COLLECTING WHAT IS DUE 

HEARING 

BEFORE THE

COMMITTEE ON FINANCE 

UNITED STATES SENATE 

ONE HUNDRED TWELFTH CONGRESS 

FIRST SESSION 

JUNE 28, 2011 

( 

Printed for the use of the Committee on Finance 

COMMITTEE ON FINANCE 

MAX BAUCUS, Montana, Chairman 

JOHN D. ROCKEFELLER IV, West Virginia 

KENT CONRAD, North Dakota 

JEFF BINGAMAN, New Mexico 

JOHN F. KERRY, Massachusetts 

RON WYDEN, Oregon 

CHARLES E. SCHUMER, New York 

DEBBIE STABENOW, Michigan 

MARIA CANTWELL, Washington 

BILL NELSON, Florida 

ROBERT MENENDEZ, New Jersey 

THOMAS R. CARPER, Delaware 

BENJAMIN L. CARDIN, Maryland 

ORRIN G. HATCH, Utah 

CHUCK GRASSLEY, Iowa 

OLYMPIA J. SNOWE, Maine 

JON KYL, Arizona 

MIKE CRAPO, Idaho 

PAT ROBERTS, Kansas 

MICHAEL B. ENZI, Wyoming 

JOHN CORNYN, Texas 

TOM COBURN, Oklahoma 

JOHN THUNE, South Dakota 

RICHARD BURR, North Carolina 

RUSSELL SULLIVAN, Staff Director 

CHRIS CAMPBELL, Republican Staff Director 

(II) 

C O N T E N T S 

OPENING STATEMENTS 

Page 

Baucus, Hon. Max, a U.S. Senator from Montana, chairman, Committee 

on Finance ............................................................................................................ 1 

Hatch, Hon. Orrin G., a U.S. Senator from Utah ................................................. 3 

WITNESSES 

Brostek, Michael, Director, Tax Policy and Administration, Strategic Issues, 

Government Accountability Office, Washington, DC ........................................ 5 

Olson, Nina E., National Taxpayer Advocate, Internal Revenue Service, 

Washington, DC ................................................................................................... 7 

Kirkham, David, president, Kirkham Motorsports, Provo, UT ............................ 9 

Carpenter, Kris, founder and CEO, Sanctuary Spa and Salon, Billings, MT .... 11 

ALPHABETICAL LISTING AND APPENDIX MATERIAL 

Baucus, Hon. Max: 

Opening statement ........................................................................................... 1 

Prepared statement .......................................................................................... 29 

Brostek, Michael: 

Testimony .......................................................................................................... 5 

Prepared statement .......................................................................................... 31 

Carpenter, Kris: 

Testimony .......................................................................................................... 11 

Prepared statement .......................................................................................... 54 

Hatch, Hon. Orrin G.: 

Opening statement ........................................................................................... 3 

Prepared statement .......................................................................................... 66 

Kirkham, David: 

Testimony .......................................................................................................... 9 

Prepared statement .......................................................................................... 68 

Olson, Nina E.: 

Testimony .......................................................................................................... 7 

Prepared statement .......................................................................................... 70 

COMMUNICATIONS

American Association of Cosmetology Schools (AACS) ......................................... 119 

Center for Fiscal Equity .......................................................................................... 121 

Professional Beauty Association (PBA) .................................................................. 123 

(III) 

(1) 

COMPLEXITY AND THE TAX GAP: 

MAKING TAX COMPLIANCE EASIER 

AND COLLECTING WHAT IS DUE 

THURSDAY, JUNE 28, 2011 

U.S. SENATE, 

COMMITTEE ON FINANCE, 

Washington, DC. 

The hearing was convened, pursuant to notice, at 10:13 a.m., in 

room SD–215, Dirksen Senate Office Building, Hon. Max Baucus 

(chairman of the committee) presiding. 

Present: Senators Conrad, Bingaman, Wyden, Carper, Hatch, 

Snowe, and Thune. 

Also present: Democratic Staff: Russ Sullivan, Staff Director; Lily 

Batchelder, Chief Tax Counsel; and Tiffany Smith, Tax Counsel. 

Republican Staff: Mark Prater, Deputy Chief of Staff and Chief Tax 

Counsel; Jim Lyons, Tax Counsel; and Bryan Hickman, Special 

Counsel. 

OPENING STATEMENT OF HON. MAX BAUCUS, A U.S. SENATOR 

FROM MONTANA, CHAIRMAN, COMMITTEE ON FINANCE 

The CHAIRMAN. The hearing will come to order. I apologize to everybody for being a bit late. Senator Hatch and I had a little business to conduct. It was very helpful. 

So we will now proceed with the hearing. 

John F. Kennedy said, ‘‘To the extent that some people are dishonest or careless in their dealings with the government, the majority is forced to carry a heavier burden.’’ 

In today’s tax code, the majority is carrying a heavy burden. It 

is a burden of hundreds of billions of dollars in taxes that are 

owed, but not paid. It is a burden that prevents us from building 

new schools or investing in cutting-edge scientific research. It is a 

burden that keeps us from paying off the debts we owe and reducing our deficits. 

According to the latest IRS estimates, the number of tax dollars that are owed, but remain unpaid is $345 billion each year. And 

I might say that latest estimate was several years ago. That is not 

the most current, which, obviously, would reach a higher level. 

This disparity is often referred to as the tax gap. Today, the tax 

gap equals nearly 20 percent of our forecasted deficit for this fiscal 

year. In short, the tax gap is more than $300 billion that we simply 

cannot afford to waste. 

Part of the tax gap is the result of tax cheats who simply refuse 

to comply with the law, which increases the burdens on the rest 

2 

of us. But a portion is due to taxpayer confusion and unintentional 

errors, as well. We can certainly all agree that the tax code is extremely complex. 

According to the IRS data, U.S. taxpayers and businesses spend 

more than 6 billion hours each year complying with the filing requirements of the Internal Revenue Code. As the Taxpayer Advocate’s 2010 annual report states, if the hours Americans spend on 

tax compliance were instead spent on an industry, it would be one 

of the largest in the United States. Six billion hours is equal to the 

work of more than 3 million full-time employees. 

Today’s hearing will focus on issues of tax complexity and the tax 

gap, as well as the correlation between them. 

Does confusion surrounding the complexities of the code lead to 

noncompliance? Can filers simply not figure out the law and how 

to comply with it? Or is the tax code so confusing because we have 

patched up loopholes and written new rules in an effort to prevent 

noncompliance? 

First, we must ask why people fail to meet their tax obligations. 

Failure to comply can take three forms—underreporting the 

amount owed, underpaying the amount a taxpayer acknowledges is 

owed, and simply not filing at all. 

Reports from the Government Accountability Office and the Joint 

Committee on Taxation have found there are two proven ways to 

reduce noncompliance—information reporting and withholding. 

IRS research supports these findings, demonstrating that more 

taxes are paid with increased information reporting. When individuals and businesses provide substantial information about spending and income, the compliance rate is over 95 percent. When there 

is little or no information reporting, the compliance rate drops to 

46 percent. 

However, recent experience suggests that, in some areas, requiring American taxpayers to file additional information reports or 

withholding taxes is simply too burdensome. 

Perhaps there are other solutions. For example, we should ask 

ourselves: Are there ways the IRS can harness new technology to 

do more with the same resources? 

IRS Commissioner Shulman has proposed changes that would 

help the agency process tax data more quickly. This upgrade would 

ensure that the IRS has the information it needs to check the accuracy of tax returns immediately after they are submitted. 

The IRS should identify errors instantly and reduce audits required down the road. 

We should also consider ways the tax code is so complex that it 

actually discourages compliance. In 1987, a year after Congress 

passed major tax reform legislation, the instruction book for the 

primary individual income tax form was 56 pages; not light reading 

by any stretch of the imagination, but only 56 pages. In 2009, that 

figure had grown to 174. 

This complexity makes it hard for taxpayers who honestly want 

to pay their taxes to figure out what they actually owe and, as a 

result, they often overpay or underpay. We must do more to understand the sources of the tax gap and compliance burdens so we can 

make progress uncovering new, creative solutions. 

3 

I have said before we should aim to reach a voluntary compliance 

rate of 90 percent by 2017. And to reach that goal, we need to 

think strategically. 

How can we reform the tax system so we can collect the revenue 

that is due to the government in the most efficient manner possible? Do we need to tear down the current system and start from 

scratch? Can we keep the foundation? Do we just need a fresh coat 

of paint? 

So let us consider solutions to close the tax gap that are both creative and efficient. Let us work to reform our code in a way that 

will help us collect more of the taxes owed, but not paid. And let 

us continue our work to make the tax code more fair and simple. 

I would like to now turn to Senator Hatch. 

[The prepared statement of Chairman Baucus appears in the appendix.] 

OPENING STATEMENT OF HON. ORRIN G. HATCH, 

A U.S. SENATOR FROM UTAH 

Senator HATCH. Thank you, Mr. Chairman. Albert Einstein once 

said that the hardest thing in the world to understand is the income tax. 

If there is one thing we can agree on as Republicans and Democrats, it is that Albert Einstein was a pretty smart guy. But with 

the Internal Revenue Code, he apparently met his match, and 

things are only getting worse. 

Year after year, the tax code becomes more complex. This has 

contributed to two separate, but related problems. First, the complexity of the code undercuts compliance. Compliance with the tax 

code should not be a choose-your-own-adventure story, where the 

complexity of the code leaves citizens guessing their tax liability. 

As Chief Justice John Marshall explained, the power to tax is the 

power to destroy. The power to tax is massive and intrusive. And 

I would have to say, given our constitutional commitment to personal liberty and the right to property, citizens should be personally well-aware of what their tax liability is. 

The second issue, and one related to the code’s complexity, is the 

tax gap. The tax gap is basically the difference between the amount 

of money that taxpayers legally owe and the amount that the government actually collects. The tax gap is the great white whale of 

deficit reduction. If only the government were able to collect what 

it is owed, our deficits would be reduced significantly. For the 2001 tax year, the IRS estimated the tax gap to be $345 

billion. Even after taking into account late payments and the IRS 

collections, that amount was estimated to be $290 billion. While 

the government should be able to reduce that amount significantly, 

it would be a mistake to put too much deficit reduction hope into 

the tax gap basket. 

As an empirical matter, it is impossible to completely eliminate 

the tax gap. For example, some taxpayers legally owe a significant 

amount of money, but do not have the assets or income to pay off 

their tax debt. As the old saying goes, you cannot squeeze blood out 

of a turnip. 

Yet, the tax gap debate has philosophical implications, as well. 

The government could close the tax gap entirely by putting IRS 

4 

agents in every family’s living room and in every small business, 

but this is a price that liberty-loving people and their representatives are rightly unwilling to pay. 

When it comes to compliance, I am convinced that the Federal 

Government is often its own worst enemy. As the code becomes 

more complex, compliance drops, and the tax gap increases. 

Consider the impact of the health spending law alone on the tax 

code. Courtesy of this law, taxpayers with flexible spending accounts, accounts designated to provide user-friendly choices to patients, now need to go to their doctor to get a prescription for overthe-counter drugs like Prilosec. 

Courtesy of this law, there is a 10-percent tax imposed if you use 

a tanning bed at a tanning salon, but not if you use one at your 

gym. 

As this committee considers ways to address the tax gap, the 

saga over the health spending law’s 1099 provision provides an instructive example. In the name of reducing the tax gap, Congress 

and the President imposed considerable burdens on individuals and 

businesses, redirecting vital resources toward additional government paperwork. 

The burdens associated with the 1099 provision were so severe 

that even the provision’s proponents were calling for its repeal soon 

after its enactment. 

Outside of health care policy, we have other examples of the political and economic difficulty of addressing the tax gap. To reduce 

the tax gap, Congress passed a provision requiring a 3-percent 

withholding on government contractors. But, as a result of the compliance burdens that it has created, Congress has already delayed 

the effective date of this provision. 

The matters being discussed today are ones that should inform 

our efforts at fundamental tax reform. As I have said before, I will 

be guided during that debate by the three criteria that President 

Reagan set out during the Tax Reform Act of 1986. 

President Reagan explained that tax reform should promote economic growth, fairness, and simplicity. Tax reform is a priority of 

this committee, and I believe that President Reagan’s three criteria 

are equally applicable today. 

The tax gap implicates President Reagan’s second criteria—fairness. When some taxpayers are paying what they owe, but their 

neighbors are not, that is unfair to the taxpayers who meet their 

obligations. In effect, it increases their share of the load. 

Furthermore, lack of compliance undermines confidence in the 

tax system, in turn leading to less voluntary compliance. In short, 

when law-abiding taxpayers think that the complexity of the code 

rewards creative accounting and that some people are getting one 

over on the government, it will make them less likely to comply 

voluntarily. 

Since our tax system collects the vast majority of its taxes 

through voluntarily compliance, maintaining and improving voluntary compliance is critical. 

Now, President Reagan’s third criteria of tax reform, simplification, is also relevant to today’s discussion. Since the Tax Reform 

Act of 1986 was enacted, Congress has passed over 14,000 amendments to the tax code. Fundamental portions of the tax code, such 

5 

as the tax rates themselves, are set to expire at the end of 2012 

unless Congress again acts to prevent a massive tax increase. 

This, unfortunately, causes uncertainty for small business owners and others and causes Americans to invest less and hire fewer 

workers than if Congress were to provide long-term assurances 

that their tax rates will not increase. 

The ever-increasing complexity of the tax code, which is only 

heightened by the temporary nature of many provisions, needs to 

be improved upon in tax reform. We need a tax code or a system 

with a more streamlined set of permanent provisions that is easier 

to comply with and less complex. 

Mr. Chairman, thank you again. I look forward to hearing the 

testimony of the witnesses, and I appreciate your holding this hearing. 

[The prepared statement of Senator Hatch appears in the appendix.] 

The CHAIRMAN. Thank you, Senator, very much. I appreciate 

your leadership and your comments. 

Our first witness is Michael Brostek, from the Government Accountability Office. Welcome again, Mr. Brostek. 

Mr. BROSTEK. Thank you. 

The CHAIRMAN. It is good to see you here. As many know, you 

are the director of Tax Policy and Administration at GAO. 

The second witness is Ms. Nina Olson. Ms. Olson has served as 

National Taxpayer Advocate, Internal Revenue Service, since 2001; 

served very well. I see your name often as you stand up for taxpayers, and we appreciate that, and you, too, obviously, have testified several times. You testified well. That is why you are back 

again. 

Next, David Kirkham. It is the first time, I think, Mr. Kirkham, 

we have had the pleasure of seeing you. You are the president of 

Kirkham Motorsports based in Provo, UT. 

Finally, Ms. Kris Carpenter, owner and operator of Sanctuary 

Spa and Salon and two retail gift stores in Billings, MT. Welcome, 

Ms. Carpenter. You are a very solid, strong businessperson, small 

businessperson, and we very much appreciate your expertise and 

your perception of how the tax code affects you. 

So let us all begin. Mr. Brostek, you are first. The usual and customary practice here is your statements are all submitted for the 

record and, meantime, just summarize your statement for about 5 

minutes. Just do not pull any punches. Say what you want to say. 

Let it all hang out for about 5 or 6 minutes. 

STATEMENT OF MICHAEL BROSTEK, DIRECTOR, TAX POLICY 

AND ADMINISTRATION, GOVERNMENT ACCOUNTABILITY OFFICE, WASHINGTON, DC 

Mr. BROSTEK. We will do that. 

The CHAIRMAN. Good. 

Mr. BROSTEK. Chairman Baucus, Ranking Member Hatch, and 

members of the committee, thank you for inviting me to discuss the 

effect of tax code complexity on taxpayer burden, economic efficiency in compliance, as well as strategies to improve compliance 

and reduce the tax gap. 

6 

My statement focuses mainly on individual taxpayers and is 

based on previous GAO work and products. 

I know I do not need to convince you the tax code is complex. You 

have just testified to that yourselves. For context, though, it is important to realize that complex provisions can have legitimate purposes. 

In an era when complex sources of income exist in a global economy, simply defining income can be complex. Complex provisions 

are also used to target tax benefits to intended populations and to 

address areas of noncompliance. 

But complexity does have costs. It creates burdens on taxpayers 

to understand complex requirements, to keep sometimes detailed 

records that may need to be retained far beyond the immediate tax 

year, and to revise their personal plans as tax laws continue to 

change. 

Estimating the dollar cost of this burden is not easy. In 2005, we 

reviewed the existing studies and found that the lowest available 

compliance cost estimates for the personal and corporate income 

taxes combined was about $107 billion per year or about 1 percent 

of gross domestic product. 

Economic efficiency costs of taxes are reductions in economic 

well-being, such as lost economic output or consumption opportunities. These, too, are difficult to estimate. 

The two most recent comprehensive studies we found in 2005 estimated the efficiency costs of Federal taxes to be 2 to 5 percent 

of GDP annually in magnitude. The complexity of measuring income affects taxpayers who receive income from sources like capital 

gains, rents, and self-employment. 

For example, capital gains or losses from selling stocks require 

individuals to have records of the date they bought and sold stock, 

purchase and sales prices, and resulting gains and losses. But they 

also need to determine whether events like stock splits occurred 

over the time that they owned the stock and take those events into 

account. 

We estimated that for tax year 2001, over one-third of taxpayers 

with such income misreported it. Two-thirds of those misreporting 

underreported their income, while one-third overpaid. 

Since then, Congress has taken steps to require dealers to track 

and calculate income for taxpayers on stock sales, a nice simplification. 

Another significant source of complexity for individuals is determining eligibility for tax expenditures—tax benefits. Several tax 

provisions intended to help taxpayers with higher education expenses are an example. 

For taxpayers, where data were available, we analyzed whether 

the taxpayers were selecting the provisions that gave them the 

most benefit. For tax year 2005, almost one in five did not use a 

provision at all when they were eligible. About 28 percent, 601,000 

taxpayers, either did not use a provision or selected one that was 

not the best for them. 

These taxpayers shortchanged themselves by hundreds of dollars. 

Although we cannot be sure these errors were due to complexity, 

it seems likely that many were. 

7 

We are not aware of any reliable estimates of how much of the 

tax gap is due to complexity, but certainly some significant portion 

is. Therefore, some strategies for reducing the tax gap may be effective if they address complexity. These strategies could include 

simplifying the code by, for instance, reducing the number of tax 

benefits that are available. 

Another strategy focusing on complexity is providing high quality 

service to taxpayers through education and outreach, clear publications explaining tax requirements, and access to telephone assistance that provides accurate guidance. 

A third complexity-related strategy is to make definitions consistent across tax provisions. Perhaps the key tax gap strategy is 

expanding information reporting. Sometimes information reporting, 

like the new requirement for basis reporting on stock sales, can reduce complexity for taxpayers. Information reporting is associated 

with very high levels of compliance. 

Other tax gap reduction strategies would focus less on helping 

taxpayers deal with complexity and more on enforcing tax code requirements. Those strategies might include devoting more resources to IRS enforcement activities and performing more checks 

of compliance before tax refunds are mailed to taxpayers. 

This concludes my statement, and I would be happy to answer 

any questions. 

[The prepared statement of Mr. Brostek appears in the appendix.] 

The CHAIRMAN. Thank you, Mr. Brostek. 

Ms. Olson, you are next. 

STATEMENT OF NINA E. OLSON, NATIONAL TAXPAYER 

ADVOCATE, INTERNAL REVENUE SERVICE, WASHINGTON, DC 

Ms. OLSON. Chairman Baucus, Ranking Member Hatch, and distinguished members of the committee, thank you for inviting me to 

testify today about complexity and the tax gap. 

Most people do their best to comply with the tax laws and procedures, and the vast majority succeeds. They voluntarily pay their 

taxes in full and on time. The IRS collects only about 3 percent of 

tax revenue as a direct result of enforcement actions. Still, the IRS 

estimates that it does not collect about 14 percent of the taxes people owe. 

To reduce the tax gap, we need to understand what is causing 

people to fail to comply. Certainly, a significant portion is due to 

deliberate underreporting, but much is not. In fact, available evidence suggests that considerable noncompliance, perhaps even 

most of it, results from inadvertent errors. 

There is no doubt that the tax code, as it stands today, imposes 

excess compliance burdens. It is rife with complexity and special 

tax breaks, helping taxpayers who can afford expensive tax advice 

and discriminating against those who cannot. 

This complexity obscures understanding and creates a sense of 

distance between taxpayers and the government, undermining taxpayer morale and leading to lower levels of voluntary compliance. 

This complexity also produces more complexity, creating a vicious 

cycle. In particular, complex laws create opportunities for abuse, 

which, in turn, spur more complex laws to stop the abuse, burVerDate Nov 24 2008 15:43 Aug 29, 2012 Jkt 000000 PO 00000 Frm 00011 Fmt 6633 Sfmt 6633 R:\DOCS\75601.000 TIMD
8 

dening everyone, including the IRS and the majority of taxpayers 

who are trying to comply with the law in the first place. 

When complexity creates opportunities for abuse, the IRS also 

tends to react with a broad enforcement-oriented approach that 

may further burden and alienate taxpayers who are trying to comply. 

When complexity trips up taxpayers and they fall behind on their 

taxes, the IRS can and should do more to address delinquency 

more quickly and to offer simple and reasonable payment alternatives to taxpayers who cannot pay in full. Otherwise, complexity 

and the IRS’s response to it will leave taxpayers who are trying to 

do the right thing unable to do so. 

When the government’s expectations are unrealistic, for example, 

when it expects that all taxpayers will be able to comply with very 

complicated rules or that taxpayers with no simple or realistic options for putting a delinquency behind them will suddenly become 

compliant, it is likely to be disappointed. 

Let me give two other examples of the effects of tax complexity. 

First, considerable attention has focused on improper payments in 

the administration of refundable tax credits, particularly in the 

earned income tax credit, or EITC, and there has been pressure on 

the IRS to give higher priority to reducing EITC over-claims. Yet, 

many over-claims are not improper claims. Rather, they are claims 

the taxpayer is not able to prove under the law’s definitional complexity and the IRS’s narrow rules for acceptable documentation 

and taxpayer-unfriendly audit procedures. 

In other words, tax law complexity has led to substantiation complexity that many low-income taxpayers cannot manage. 

Economically, there is no difference between an overpayment of 

a refundable credit and a tax underpayment due to underreporting. 

Whether a taxpayer underreports gross income by an amount that 

leads to a $500 tax underpayment or the IRS pays a $500 tax credit to an ineligible taxpayer, the result is the same. The public 

treasury is out $500. 

Improper EITC payments amount to only about 5 percent of the 

estimated tax gap, and taxpayers claiming the EITC are already 

subject to audits at more than twice the rate of the average individual taxpayer. 

Thus, we must be very careful not to let the improper payment 

terminology cloud our perspective here and drive us to impose compliance rules that impose excessive burden on taxpayers and the 

IRS alike. 

Measures such as expanded math error authority and requirements to submit documentation with tax returns may fall into this 

category. 

On a related point, the IRS’s increasing use of automated processes in place of human judgment and discretion in an effort to 

achieve efficiencies, particularly in the area of penalty administration, increases the risk that the government will act arbitrarily and 

capriciously; that is, without rationale. This, in turn, also undermines compliance. 

In sum, I agree with the premise of this hearing: namely, that 

complexity promotes noncompliance and contributes to the tax gap. 

Although I support comprehensive tax reform, my written stateVerDate Nov 24 2008 15:43 Aug 29, 2012 Jkt 000000 PO 00000 Frm 00012 Fmt 6633 Sfmt 6633 R:\DOCS\75601.000 TIMD
9 

ment identifies many areas where we could simplify the tax code 

and procedures even if comprehensive tax reform cannot be 

achieved in the near term. 

Thank you. 

[The prepared statement of Ms. Olson appears in the appendix.] 

The CHAIRMAN. Thank you, Ms. Olson. 

Mr. Kirkham, you are next. 

STATEMENT OF DAVID KIRKHAM, PRESIDENT, 

KIRKHAM MOTORSPORTS, PROVO, UT 

Mr. KIRKHAM. Chairman Baucus, thank you. Senator Hatch, 

thank you for inviting me here. 

The CHAIRMAN. You may want to bring your microphone a little 

closer. 

Mr. KIRKHAM. My microphone was not on. 

The CHAIRMAN. It helps. Thanks. 

Mr. KIRKHAM. Chairman Baucus, thank you for having me here 

today. Senator Hatch, thank you so much for inviting me to speak. 

And thank you to the other members of the committee who are 

here. 

I would like to paint a picture today of what we are really talking about. What we are really talking about is jobs. And I do business all over the world, and I have seen jobs, and I have seen this 

road of tax complexity, and I have seen this road of tax gap and 

massive enforcement, and I have seen where it ends. 

I have been to Russia, I have been to Poland—I own a factory 

in Poland—been to Greece, done business all over the world. 

Can you pull that photograph up? This is a picture from a 

website. This is who I am, that is what I do. I make really cool 

cars. I went to Poland. I went to an old MIG fighter factory in Poland in 1995 and, when I got there, you know what? The lights 

were off. Men would stand behind their machines in the dark when 

they got to work at 7 in the morning. And they went home at 3 

in the afternoon, and they stood there all day with nothing to do. 

That is what I walked into, and that is the road we are on. 

In 2005, I had grown that company, along with my brother, to 

75 employees in Poland. I was there—many of those guys I hired, 

I was there the day they were fired and let go from that factory, 

and I watched them walk out the door. 

I watched them walk out in the cold. I watched them in the 

snow. I watched them get on their bicycles, and I watched them 

leave. Their government had failed them. 

The next week, about 100 of them lined up at my doors and 

begged for work. That is what we are talking about. We are talking 

about massive unemployment. We are talking about who I am, 

what I want to do. I want to hire people. That is what I want to 

do. 

But you know what? In 2005, I had had all I could take of socialism. And those 75 guys I had in Poland, I had to write down when 

I bought the lights, I had to write down when I turned them on, 

I had to write down when I pulled them out, I had to write down 

when I threw them away and where I disposed of them. And I 

could not take it anymore. I could not take all of the regulations. 

I could not take all the complexity. And I let them go, 66 guys. 

10 

I want to know who is the voice for 66 men that I let go. I turned 

them into very high-tech state-of-the-art equipment at my factory 

in Provo. That is what we are talking about. We are talking about 

jobs. 

It is immoral for you guys to have laws that are so complex that 

I have to hire somebody to figure out how to comply with them. I 

have to hire tax attorneys, I have to hire accountants, I have to 

hire bookkeepers, and they cost a lot of money. I spend $100,000 a year on this. Do you know how many jobs I 

could provide with that? Do you know how many other people I 

could employ? 

Let us say I could hire two more guys. Maybe I could hire three 

more guys. Maybe those three guys would make me so much more 

productive and my brother and our company that I could hire another four, I could hire another five. And, yet, I cannot. Why? Because I have to spend my time figuring out how to pay the least 

amount of taxes possible. 

I have a fiduciary responsibility to my company and to my employees to pay the least amount of tax I possibly can, that I legally 

possibly can, and every business in this country does the same. 

They have to. That is their job. 

If you would please make the tax code easier, you know what? 

You would get a lot more compliance. People want the tax code to 

be fairer, they want it to be open, they want it to be transparent. 

I frequent a site where we make these cars, and it is called Club 

Cobra. I have dear friends on that site. Most of them are businessmen who own these cars, and those are the guys I talk to every 

day. And I posted, ‘‘Hey, I am going to go give some testimony before the Senate committee on tax complexity. What do you guys 

think? What should I say?’’ 

You know, not one of those men posted, ‘‘I want to evade taxes.’’ 

Not one. Every one of them said, ‘‘David, tell them that we want 

these taxes simpler. Tell them that we want to comply, but I do 

not want to sit here and wonder how I am going to pay my taxes. 

I do not want to have to find attorneys making mountains of 

worthless paperwork.’’ 

That is what we are talking about. You guys wonder why we 

have unemployment. I will tell you why we have unemployment. 

Because we cannot figure out how to pay our taxes. We cannot figure out what we are going to do, how we are going to hire, and we 

are scared. 

Obamacare comes along, all these other issues come along—Senator Hatch mentioned many things in his statement. I absolutely 

agree with them. And the business owners say money is a coward, 

it runs and hides. It gets scared. That is what happens. When the 

businessmen run and they hide, you know what? They put their 

money into bank accounts and they do not take it and they do not 

hire people. 

I traveled to Greece—I will never forget this. I traveled to Greece 

last year to a guy who wanted to make a new car, and he was like, 

‘‘You know, David, you make really cool cars, you can make my car, 

too.’’ And so I packed up, I went to Athens, and when I went there, 

of course, I got to see all the riots. And I will never forget walking 

into this guy’s basement. 

11 

That is where he had all his employees. It was 600,000 Euros for 

this guy to get a business license. He said, ‘‘You know what? I am 

not going to do it. I’m going to send the jobs to Provo, UT.’’ 

That is called capital flight, and we are seeing it in our own 

country. 

If there is anything I could say today, it is let us be free. Really, 

what do you want me doing? Do you want me making cars? Do you 

want me creating jobs, or do you want me here in Washington, DC 

protesting your jobs? Because that is what I have been doing with 

FreedomWorks for the past 4 days. 

And you know what? I would rather not do that. I would rather 

not hold tea parties. I would rather not be yelling. I would rather 

be making cars, because that is what I want to do. 

Thank you. 

[The prepared statement of Mr. Kirkham appears in the appendix.] 

The CHAIRMAN. Thank you, Mr. Kirkham. 

Ms. Carpenter, you are last. 

STATEMENT OF KRIS CARPENTER, FOUNDER AND CEO, 

SANCTUARY SPA AND SALON, BILLINGS, MT 

Ms. CARPENTER. Chairman Baucus, Ranking Member Hatch, and 

members of the committee, I am a salon owner from Billings, MT, 

and I want to thank you for the opportunity to testify before you 

about what I have experienced in my industry regarding tax compliance. 

I have been in business for 13 years and employ 40 women; 22 

of them are salon and spa service providers who accept tip income. 

In addition to running my salon and two other retail businesses, 

I am a member of the Professional Beauty Association. PBA has 

over 8,000 members, representing salon and spa owners, manufacturers and distributors, and individual licensed cosmetologists. 

The salon industry is an industry of small businesses. It is a vibrant part of the U.S. economy, with more than 900,000 establishments and reported annual sales of nearly $40 billion. More than 

1.1 million professionals work in personal appearance occupations, 

and one out of three do so as self-employed workers rather than 

employees, a fact that is central to the salon and spa problem of 

tax complexity and compliance. 

Senator Snowe’s introduction of Senate bill 947, the Small Business Tax Equalization Compliance Act, is promising news. The legislation originally came about because salon owners like me contacted Congress about the widespread problems associated with tip 

reporting. 

It extends existing law to permit salon employers to claim the 

45(b) tip tax credit that is currently available only to restaurants. 

The bill also provided assistance to the Federal Government by improving tip reporting in all sectors of the salon industry. 

Salon owners must collect and report tip information from their 

employees to the IRS and pay FICA taxes on the reported tips. 

However, unlike the restaurant industry, salons are not eligible to 

claim the tax credit for FICA taxes paid on those tips. 

Unlike most tipped industries, a large segment of the salon industry is classified as self-employed. While two salons may look the 

12 

same, one classifies the people behind the chairs as employees, 

while the other classifies its workers as self-employed or independent contractors. 

The bottom line is that currently the tip reporting burden is 

greatest on small business owners like myself. Self-employment is 

significant and growing. In 2010, the average hourly wage of my 

service providers was $14.31, and the average reported tip income 

was $6.33 an hour. I pay my employees a fair wage, pay 65 percent 

of my employees’ health insurance premiums, provide them with a 

401(k) and profit-sharing opportunities. 

Ten years ago, we began recording the tips received by our employees in our point-of-sale software. The amount recorded and reported was astounding to me. Prior to this accounting, I estimate 

that only 25 percent of the actual tip income was reported by our 

employees to Sanctuary. 

Over this 10-year period, we will have reported $1.7 million in 

tip income from our employees. And remember, I am a salon in Billings, MT, and our average service ticket is $46. 

Last year, we reported tip income of over $225,000, and that 

equaled 15 percent of our service sales. The cost to Sanctuary to 

match the FICA taxes on the employees’ tip income was over 

$16,000. This places a significant burden on my business’s ability 

to stay profitable while continuing to provide good benefits for our 

employees, and this kind of comprehensive accounting reporting is 

not a common practice in my industry. 

Over the past 10 years, I have lost several employees to a lure 

of renting a chair. The ease of not fully reporting income or tip income, along with the common misconception by individuals in my 

industry that tips are gifts, not income, puts my business at a competitive disadvantage for hiring and retaining employees. 

I believe it is unfair that individuals in our industry are able to 

take an extra $5-plus an hour in unreported income. Teachers, soldiers, bankers, grocery clerks, and other workers in this country 

are not allowed that choice with their income. 

When you do the right thing, it should not put you at a disadvantage to those who do not. 

I would like to see the gap and this unlawful practice narrowed. 

Two suggestions that I would like to put forth are, one, the Congress should pass Senate bill 974. The salon owners who are reluctant to comply because of the cost of the FICA match will be relieved of that burden, and the Treasury will increase its collections 

of taxes owed. 

Number two, the IRS needs to systemize contacts with the selfemployed. Their contact with the employers and industry has increased compliance. There is not an equal level of contact with the 

self-employed. 

Thank you for the opportunity to share these ideas. I appreciate 

your support for my industry and look forward to working together 

towards a long-term solution. 

Thank you. 

The CHAIRMAN. Thank you, Ms. Carpenter. 

[The prepared statement of Ms. Carpenter appears in the appendix.] 

13 

The CHAIRMAN. I would like to go back to Mr. Kirkham. Everybody wants the code to be simpler. Where would you simplify, what 

examples? 

Mr. KIRKHAM. I would eliminate all loopholes that you can find. 

The CHAIRMAN. And which would those be? 

Mr. KIRKHAM. I am not a tax expert, nor do I profess to be. I pay 

somebody else to do that. But we all know of tax loopholes, because 

GE did not pay any taxes last year. 

You have to eliminate loopholes, lower the rates, make it open, 

transparent, and fair. 

The CHAIRMAN. I guess there are a lot of questions along that 

line, like some people think some provisions are loopholes, some do 

not think they are loopholes. 

Let us take the mortgage interest deduction. Some would suggest 

that is a loophole and some would say, no, no, that is not a loophole 

because a lot of people want to own houses. 

Do you have any thoughts on that one? 

Mr. KIRKHAM. I would eliminate all loopholes that you can, including the mortgage interest deduction. I would make it fair for 

everyone. 

Who are you really hurting? Who are the people who get that? 

The CHAIRMAN. I am just trying to get a sense of your proposal. 

So eliminate all loopholes. I assume you are saying essentially 

eliminate all—— 

Mr. KIRKHAM. I would move to a—I am sorry. 

The CHAIRMAN. Flat tax? 

Mr. KIRKHAM. I do not know. I do not know the ins and outs. 

Again, I am no expert. I would look into a flat tax. I would look 

into a fair tax. I would look into any of those proposals—— 

The CHAIRMAN. And what if—what if—— 

Mr. KIRKHAM [continuing]. That can make it easier. 

The CHAIRMAN. Right. Right. Now, what if the results—anything 

that is enacted here generally results in some winners and some 

losers. That is, some people end up paying more and some people 

end up paying less. 

Let us assume that we had a flat tax. Under a flat tax, let us 

assume, for the sake of discussion, the same amount of revenue 

that is earned today. One could say it should be higher or lower, 

but let us say, just for the sake of discussion, it is about the same 

as revenue earned today. 

Under a flat tax, some people would pay more in taxes than they 

pay today, and some people would be paying less than they pay 

today. And the people who would be paying more under a flat tax 

would be average Americans. The average American would be paying quite a bit more than he or she pays today. And, under a flat 

tax, the person paying quite a bit less than he or she pays today 

would be the most wealthy. 

My question is, does that result comport with kind of your thinking? It is simple, but would that be fair? 

Mr. KIRKHAM. I think fair is fair. I think if everybody is paying 

the same rate, everybody is fair. I am not saying that the very 

lower income levels should not have some sort of relief of some 

sort. No one that I know thinks that. Everybody wants to help 

those who are in poverty. 

14 

You refer to the people at the top. I read in the news today there 

was a big complaint in the New York Times, where they said many 

people with capital gains and all sorts of things are able to use 

loopholes to defer income, or they take a loss last year, and they 

are not paying tax this year. 

So I think it is so complex, I do not think you know; I do not 

think I know. That is no disrespect. I do not think any of us knows 

what is going on with this tax code. It needs to be fair. Everybody 

needs a piece of the game. 

The CHAIRMAN. I have to get on with the other witnesses here. 

But clearly, fairness is in the eyes of the beholder. What some people think is fair, some other people think may be not so fair. Again, 

some people think very low-income people should get a significant 

break. 

Some people think—— 

Mr. KIRKHAM. I am not opposed. 

The CHAIRMAN [continuing]. The upper, very, very wealthy 

should not get the same break as the very low-income break. Some 

people would think that. 

Mr. KIRKHAM. I think you would be surprised. If you were to 

have—if the people in the top end of the bracket—what do they do 

with their money? They do not look at it. They invest it. That is 

how people like me start businesses. 

The CHAIRMAN. So what are you saying? I do not understand. 

Mr. KIRKHAM. It should be fair for everyone. I am not opposed 

to any sort of a break for people who are in poverty, by any stretch. 

I was a missionary in Peru, and I have walked among the desperately poor. They have a very dear place in my heart. I will not 

abandon them. 

However, once we get past some level of poverty that we can all 

agree on, open, fair, 10 percent, 20, whatever that is, it needs to 

be fair beyond that. 

I think you would be surprised at how much revenue would actually come in. 

The CHAIRMAN. Let me ask just a basic question. My time has 

about expired. All three of you—it will have to be very brief answers. 

Is most of the so-called tax gap, in your judgment, intentional, 

or is most of it just mistakes, unintentional mistakes? 

Mr. Brostek? 

Mr. BROSTEK. Well, as I said in my oral statement, I am really 

not aware of any reliable estimate on that. It is trying to get into 

someone’s head and decide, why did they make an error, and that 

is a very difficult thing to do. 

The CHAIRMAN. Your best guess. 

Mr. BROSTEK. I think it varies all over the place. What we know 

is that, when the transactions that affect income are not transparent to IRS, compliance is much lower. So where there is an opportunity to be noncompliant, there is much more noncompliance. 

The CHAIRMAN. Ms. Olson, why don’t you try? 

Ms. OLSON. Well, the largest portion of the tax gap is underreporting income. So it is either people not reporting the income 

that they made, or that they are taking deductions that they 

15 

should not be taking. And on the deduction side, I would say that 

is where you might have complexity. 

On the underreporting of your gross income, I think you might 

see the effect of people feeling—that is the tax morale issue, that 

people feel that somebody else is getting away with something, so 

I am going to create a tax break of my own. The income is not reported to the IRS. The IRS does not know it. So what they do not 

know, they will never find out unless they come and find me. 

The CHAIRMAN. Mr. Kirkham, I will ask you the same question. 

You seemed a little irritated. 

Mr. KIRKHAM. No, I was not irritated. I was absolutely agreeing. 

The CHAIRMAN. No, no. You seem to have strongly held views 

that the code is not fair. 

Mr. KIRKHAM. It cannot be if it is 70,000 pages long. 

The CHAIRMAN. So my question is, do people in your business or 

businesses, because they feel that the code is not fair, tend to 

underreport? 

Mr. KIRKHAM. I was not referring to my businesses. I was referring to many things that I have heard other people say. 

The CHAIRMAN. By other people, do you think—— 

Mr. KIRKHAM. Just other people. It is only human nature. 

The CHAIRMAN. No, I am asking—if I can ask this very simple 

question. Do you think that the people you talk to who think the 

code is unfair, do you think they, therefore, because they think it 

is unfair, tend to underreport? 

Mr. KIRKHAM. I think that is undeniable. They feel it is too complex. They feel like other people are getting away with it. Let us 

face it. When GE is not paying taxes, which is their, again, fiduciary responsibility to minimize those as much as they can, it is 

their duty to their shareholders, what does the average little guy 

think? 

The CHAIRMAN. Ms. Carpenter, my time is up, but what do you 

think most people—is the tax gap just due to innocent mistakes, 

or is it due to ‘‘I am going to over-expense this item’’ or ‘‘I am just 

not going to report’’? 

Ms. CARPENTER. I do not think a lot of it is mistakes. I think a 

lot of it is the ease of not reporting, especially in my industry. It 

is easy. Anything that is cash disappears. 

The CHAIRMAN. Thanks very much. 

Senator Hatch? 

Senator HATCH. Well, I want you to know, Mr. Kirkham, I agree 

with you. 

Mr. KIRKHAM. Thank you. 

Senator HATCH. The code is so doggone complex that nobody understands it. I would venture to say there is hardly a person on 

this committee who does not hire tax attorneys or accountants to 

prepare their income tax returns, because it is just so complex that 

it is very difficult for us to do it, and yet we are the tax-writing 

committee. 

So your points here are very well-made, very well-taken. And I 

think the points of everybody here have been—I do not mean to 

single you out, except I actually believe that you have spoken a lot 

of wisdom and a lot of practical wisdom here today. 

16 

Everybody hates the tax code, and there is good reason for it. 

And I think it is incumbent upon this committee to come up with 

a simplified version of the tax code that will cause people to comply. And I agree with you. We would have a lot more revenues 

come in to this government if people did not think they were being 

ripped off by the government, and, if 51 percent of them who do 

not pay income taxes now would pay, 51 percent of households, 

that is, would pay income taxes, or at least those who are not in 

poverty would pay income taxes. 

Ms. Olson, you appropriately point out in your testimony that tax 

simplification is a requirement of greater tax compliance, the same 

thing that Mr. Kirkham is saying here, and Ms. Carpenter as well. 

And we ought to listen to you guys. 

Not to get too philosophical, but are there not other reasons for 

simplification as well? Most citizens who are not lawyers have little 

interaction with the United States Code, and the exception is with 

the Internal Revenue Code, which also happens to be the part of 

the code that most regularly impacts the individual rights to liberty and property. 

Beyond compliance, is it not also just that, in a democracy committed to individual rights, people should be able to understand the 

law that they are forced to comply with? And assuming the answer 

is yes, and I hope it is, I encourage all our witnesses to elaborate, 

if you will. 

But we will go to you, first, and then to you, Mr. Brostek, you, 

Mr. Kirkham, and you, Ms. Carpenter. 

Ms. OLSON. I think, as you point out, that United States taxpayers’ interaction with their government, it is through the tax 

code; that perhaps in retirement, you have interaction with Social 

Security, but even in retirement, you have interaction with the IRS 

as well. 

And the IRS is the face of the tax code, and as taxpayers experience arbitrary, capricious, confusing, unexplained results and look 

around and see different results for them from similarly situated 

others, or they go to cocktail parties and they hear about how one 

person is doing something that they did not think to do—— 

Senator HATCH. You seem to be saying pretty much the same 

thing Mr. Kirkham has. 

Ms. OLSON [continuing]. These all undermine confidence and 

erode the social contract, where we, as the government, are asking 

taxpayers to voluntarily come forward and tell us their most personal information, their financial information, and, in return, we 

are going to treat them well. And complexity makes it hard for the 

IRS to treat all taxpayers well, because it is just so complex for 

them even. 

Senator HATCH. Mr. Brostek? 

Mr. BROSTEK. Well, part of your question was whether there are 

other effects of complexity besides on compliance, and there are. 

There are economic efficiency effects for the country. 

Many of the tax expenditures, tax benefits, are intended to encourage some kind of activity, to correct market failure. But, if 

those interventions are not working well, we can actually be causing more harm to the economy than we are benefitting the economy. 

17 

Senator HATCH. I would be interested in you sending us a letter 

telling us which ones you think work well and which ones do not 

work well. 

Mr. BROSTEK. I am afraid I do not have the full inventory, but 

I can make sure that you get the products that we have put out 

on this. 

Senator HATCH. That would be great. 

Mr. Kirkham? 

Mr. KIRKHAM. I would just add that the earned income tax credit 

is welfare, and that is okay, but it ought to be in the welfare department. It should not be in the tax department. 

Your tax code should—again, this is complexity. Your tax code 

should be your tax code. Your social services code should be your 

social code. And in that, we should vote. It should be up for vote. 

Hey, we want to put this much money into social services, great. 

We want to put this into the tax code, great. 

But from a business standpoint, when we have all these things 

that we are doing and all these withholdings, it becomes—it is an 

avalanche, it is a tsunami that buries us, which makes it so that 

we have to hire a lot of people to help us out. 

Senator HATCH. Thank you. 

Ms. Carpenter? 

Ms. CARPENTER. Well, I just find that the complexity is challenging for me as a business owner. I spend a lot of time trying 

to figure out how to do the right thing rather than growing great 

businesses and providing jobs, and it just—it has taken more than 

I would have ever imagined to learn what I had to learn to comply, 

and it is complicated. 

Senator HATCH. Let me just say to all of you—my time is up, but 

let me just say to all of you that I think this has been a very interesting panel, and I think we on this committee have an obligation 

to somehow or other do our best to simplify this tax code so that 

everybody is treated fairly, and that is a big assignment, a big job. 

And it is not just hammering one part of the economic spectrum 

because they are wealthy, and it is not just letting 51 percent of 

households off from paying income taxes. It seems to me there has 

to be some way of everybody having an appropriate amount of skin 

in this game, if you want to call it that. And I think you all make 

some pretty good points here. I am paying attention, and I hope everybody else is. 

Thank you, Mr. Chairman. 

The CHAIRMAN. Thank you, Senator. I think you are right. Since 

1986, I think you yourself pointed out that there were close to 

14,000 changes to the tax code, just layer upon layer upon layer. 

Senator HATCH. And part of that is this committee. 

The CHAIRMAN. Well, it is the Congress. 

Senator HATCH. Well, it is Congress as a whole, but this committee should stop it, and that is what they are saying to us. 

The CHAIRMAN. And that is the reason why we are holding the 

tax reform hearings. It is both individual income tax and corporate 

income tax reform here. The code has to be reformed, and the sooner the better. In fact, I think we are at a stage in American history 

where we may have some fairly radical changes over the next couVerDate Nov 24 2008 15:43 Aug 29, 2012 Jkt 000000 PO 00000 Frm 00021 Fmt 6633 Sfmt 6633 R:\DOCS\75601.000 TIMD
18 

ple of years to the code, due basically to the kinds of problems that 

we are hearing today—legitimate problems, legitimate concerns. 

Senator HATCH. Well, I would like to get it to where we do not 

play politics with it, and we do what is in the best interest of everybody and do what is fair and simple and workable. And, if we 

can arrive at that, my gosh, you and I could—we could go home 

and feel pretty good about it. 

The CHAIRMAN. Yes, we could. 

Senator Bingaman? 

Senator BINGAMAN. Thank you, Mr. Chairman. Thank you all for 

being here. 

There is a good article in the New York Times this morning by 

Bruce Bartlett, who used to be on the staffs of Jack Kemp and Ron 

Paul and worked in the Reagan and Bush administrations—the 

George H.W. Bush administration. 

Anyway, he says—I think everybody would agree with this—he says there are 78,000 tax filers with incomes of $211,000 to 

$533,000 who will pay no Federal income taxes this year. Even 

more amazingly, there are 24,000 households with incomes of 

$533,000 to $2.2 million with zero income tax liability, and 3,000 

tax filers with incomes above $2.2 million with the same Federal 

income tax liability as most of those with incomes barely above the 

poverty level. 

And then he says, perhaps the right and the left can at least 

agree that it is unseemly for those in the top 1 percent of income 

distribution, with incomes at least 10 times the median income, to 

pay no Federal income taxes. 

So I assume everybody agrees with that. I just thought it was an 

interesting point to be hearing from Mr. Bartlett at this point. 

Let me ask you, Ms. Olson, about your point. You said that 5 

percent of the tax gap is the result of overpayments of the earned 

income tax credit, as I understand it, or people claiming—— 

Ms. OLSON. Over-claims, yes. 

Senator BINGAMAN. Over-claims; people claiming that when they 

should not. 

Most of the rest, as I understood what you said, most of the rest 

of the tax gap is the result of underreporting of income, either people who just basically do not report enough of their gross income, 

they leave things out, or people who take deductions that they 

should not take. 

Between those two, which of the two is the biggest problem, as 

you see it: people failing or refusing or purposely not reporting 

their gross income properly, or people taking deductions they 

should not take? 

Ms. OLSON. Well, the IRS’s 2001 figures—and so we only know 

this from 2001; they are not updated yet—but 55 percent of the individual tax gap is attributable to unreported business income. And 

so it is $197 billion. 

Senator BINGAMAN. And is there a proposed fix for that that you 

are urging us to adopt? 

Ms. OLSON. Well, I think it is a combination of things that can 

be fixed. Certainly, some of the provisions that Congress has already passed about the reporting of credit card payments, gross income reported in that way, will help. 

19 

I think some of the proposals that Ms. Carpenter is talking 

about, where you are equalizing between those who are paying people as employees and those who are doing things as self-employed, 

will help. 

I think there are other ways of looking at it where you—there 

is always going to be some underreporting. I also have to say I 

think that education and doing well-placed enforcement approaches 

has an indirect effect on everyone. 

So, if the IRS goes out and does some well-placed audits in industries where we know there is massive underreporting, then you 

get a ripple effect, where people will be compliant for a period. And 

you do not have to do very many audits; they just have to be the 

right ones. So that word of mouth works. 

Senator BINGAMAN. You also said that there is a significant problem with people taking deductions they should not take. 

Are there a few, two or three or four deductions that are the 

worst offenders in that area that we could target in on, and either 

eliminate those deductions for everybody or find some way to see 

that they are only taken by those who are entitled to them? 

Ms. OLSON. Well, I think, surprisingly, a lot of the itemized deductions, things like charitable contributions, where people do a lot 

of fudging, I think, that is a real policy call for Congress whether 

they want to eliminate that or not. 

Then again, the independent contractor-employee issue is a big 

one. Home office deduction, there is a lot of noncompliance in it, 

because it is confusing, and we have proposed a standard deduction 

for the home office, in a way, to give people some certainty; if you 

claim that, you know you will get it, you will get it right, you will 

get it correct, rather than fudging with it or not knowing whether 

you have gotten the right amount. 

I think there are some real opportunities there. 

Senator BINGAMAN. I think my time is up, Mr. Chairman. 

The CHAIRMAN. Senator Wyden? 

Senator WYDEN. Thank you very much, Mr. Chairman. 

Let me start with you, Ms. Olson, and ask about the alternative 

minimum tax. My sense is to the middle-class taxpayer, this is just 

bureaucratic water torture. If you are a middle-class person, you 

are, in effect, filling out your taxes twice under separate systems. 

Do you think that if you repealed the alternative minimum tax, 

that that would go a significant way toward simplifying the system 

for the individual? 

I am not saying it is going to, obviously, take care of all simplification issues, but do you believe that repealing the alternative 

minimum tax would go a significant way towards simplifying the 

tax system? 

Ms. OLSON. Absolutely. We have recommended that for years. We 

did a calculation, taking the Brady Bunch as an example, and determined that they would be better off living—cohabiting rather 

than getting married because of the impact of the alternative minimum tax on their combined household as a married couple. 

Senator WYDEN. One other question for you on this simplicity 

issue in terms of steps that could be taken quickly. Do you believe 

that if you were to go to a purely voluntary approach, purely voluntary, and say that taxpayers could have the option to have the 

20 

IRS calculate what the taxpayer owes and then send the taxpayer 

a pre-filled-out form, and the taxpayer either could submit it or 

they could correct it or revise it, that that, too, would go a significant way towards simplifying the system? 

Ms. OLSON. I think for a class of taxpayers, that is possible and 

would be very helpful. I think going to what Chairman Baucus said 

earlier, the IRS needs to get this information early in order to do 

it. We cannot do it now. 

It will also have huge compliance effects for those people who get 

refunds because they underreport income and later we have to 

catch them and try to pull it back. So it really will benefit lots of 

people if we can do that. 

Senator WYDEN. One of the reasons that I have been supportive 

of this approach is it tracks very much with your concept of a voluntary focus to improving compliance. 

Really, when you look at your testimony, you go to this question 

of a voluntary approach continually, and that is the way I would 

envision this. Nobody would ever be required to do it. But if someone voluntarily wanted to do it, they could. 

Now, one taxpayer group has said that this kind of approach creates a conflict of interest. Now, I find that a little bit odd to conclude if you are talking about something that is purely voluntary. 

As the independent advocate for taxpayers, do you see this type 

of voluntary system giving taxpayers—when you give taxpayers the 

option to use it or not, would you say that is a conflict of interest? 

Ms. OLSON. I have never understood that statement. It is based 

on the thought that we would be able to see—when people electronically file or something, we would be able to see erasures or 

over-typing. And as someone who has seen penciled-in returns that 

people submit, you can see erasures on existing returns today. I 

mean, we do get the data. So I do not see the conflict. 

Senator WYDEN. One question for you, Mr. Brostek. I was interested in your idea that the code should have, on an ongoing basis, 

a periodic review. It seems to me that, especially when we get a 

tax reform bill, a major tax reform effort that simplifies the code, 

reduces a lot of the narrow breaks to hold down rates and keep 

progressivity, unless you have something like what you are talking 

about, it will almost be natural that people will keep coming back 

to add again and again and again. 

And your idea of a periodic review—I think both you and Ms. 

Olson have talked about this in the past. Maybe I can bring both 

of you into this discussion. How would you do such a thing, and 

what would be the benefits? 

Mr. BROSTEK. Well, I am not sure what would be the very best 

way, but what you want, if you are doing a review, is to know 

whether the provisions that you have are effective. 

So you want someone to be gathering the information and doing 

the analysis so they can come back to you and give you some data 

to make a decision about whether a provision that has been adopted is worth having. 

So there could be some kind of a schedule for doing that over 

time. You might start with the largest ones first, but that would 

be the basic thing that you would want. 

21 

Senator WYDEN. My time has expired. And I noted that in your 

testimony as well, Ms. Olson, and I think that is a constructive 

idea. 

Thank you, Mr. Chairman. 

The CHAIRMAN. Thank you very much. Thank you, Senator. 

Senator Carper? 

Senator CARPER. Thank you, Mr. Chairman. And to our witnesses, welcome. Thank you all for being here today. And I especially want to thank Mr. Brostek and the folks at GAO and Ms. 

Olson for your input and availability, as my staff and I have 

worked on tax gap legislation again this year as we have in the last 

Congress. 

One of the things I like to do whenever we are discussing 

changes in the tax code or tax reform, I like to ask basically four 

questions. 

The first of those is, is it fair? Second of those is, how does it promote economic growth and predictability and certainty? Number 

three is, how does it affect budget deficits? And number four, does 

it simplify the tax code or make it even more complex? 

I think those are four pretty good guidelines. You look through 

those questions almost like a prism as you evaluate the different 

proposals that are before us. 

Our country is facing, as we know, staggering budget deficits this 

year and in years to come, and it is imperative that we put our 

country back on the right fiscally responsible track. 

As this hearing highlights, one way to help get our deficits under 

control is to address the tax gap. I think it offends most of us— 

and we have heard some of this this morning—it offends most of 

us who think we are paying our fair share of taxes to know there 

are a lot of people who are not doing that, and I am told that the 

tax gap, the last time it was calculated, was close to $300 billion 

in 2001, probably larger today. 

Ms. Olson, you have estimated that each taxpayer is subsidizing—I think you said subsidizing noncompliance, which basically means we are paying $2,000 or more apiece to make up for 

folks who are not paying their fair share, in some cases by accident, and in some cases, it is purposeful. 

And that is why I am introducing legislation today that is called 

the Tax Gap Act of 2011, which would reduce opportunities for 

noncompliance, simplify filing requirements, would crack down on 

lawbreakers, and ultimately reduce compliance burdens on lawabiding taxpayers. 

This bill incorporates a number of ideas that have been proposed 

by former President Bush and his administration and by the 

Obama administration, as well as a number of other just commonsense initiatives. 

I believe that enacting this legislation will be an important step 

forward in reducing deficits and hopefully in making our tax system fairer. 

With that said, however, Ms. Olson and Mr. Brostek, I ask you, 

what else can we be doing? And in your testimony, as you highlighted here, there is noncompliance, and you made suggestions for 

ways to reduce both deliberate and accidental noncompliance. 

22 

I would like to ask each of you just to take a minute or two and 

tell us on the committee which one or two ideas among the ones 

that you have highlighted here would present the best opportunities for reducing the tax gap. 

Mr. Brostek, why don’t you go first? And then Ms. Olson. 

Mr. BROSTEK. Well, there are so many opportunities, it is hard 

to say what is really the best way. The overall best way is always 

to try to get information reporting on income or deductions. But the 

low-hanging fruit has been picked there. So it is more difficult now 

to figure out how to get that kind of transparency over income or 

deductions. 

But one of the things that we can do is make better use of the 

information returns that we currently get. So, for instance, we have 

had some work where we looked at the mortgage interest deduction 

and compliance with that. And some simple things, like recording 

the property address on the 1098 that comes in or recording whether there was a refinancing in that year or what the total mortgage 

amount is could help IRS in policing the various requirements for 

that. 

For students, the institutions, the educational institutions send 

IRS—— 

Senator CARPER. By the way, I believe my staff just told me our 

bill that I just mentioned actually does that. So thank you. 

Mr. BROSTEK. For educational institutions, they send taxpayers 

a 1098–T, but they can report either the amount that they billed 

or the amount that someone paid. 

All that information is not useful to IRS unless it is really the 

amount paid, because that is the amount that is deductible. So we 

could revise that form to require the information that is actually 

actionable by IRS. 

Senator CARPER. All right. Thank you. 

Ms. Olson? 

Ms. OLSON. Well, in my testimony, I list several recommendations, including education and retirement provisions. But in my 

last year’s annual report, one thing that I recommended was that, 

as Congress decides whether to implement a policy through the Internal Revenue Code, it should go through an analysis, beyond just 

the public policy, that it is a good public policy to support this provision, but is it something that we can do well through the code. 

And there may be times where we conclude that doing it through 

the tax system makes sense. It puts the least burden on the beneficiary, and it is something the IRS can manage. 

And to Mr. Brostek’s point, we get the data that we can give 

Congress to evaluate whether this provision is actually fulfilling its 

public policy objective. Right now, we have so many provisions in 

the code, and we have no data. 

The IRS itself cannot gather it because it is really economic information external to the IRS, and there is no mechanism for coming back in and saying, ‘‘Okay, we have put this provision in. Does 

it make sense?’’ If it does not, then we can get rid of some complexity by moving it out, and I think that kind of discipline is vital, 

both as part of tax reform, and on an ongoing basis. 

Senator CARPER. Thanks for those responses. And, since my time 

has expired, I just want to thank all of you for being here and sharVerDate Nov 24 2008 15:43 Aug 29, 2012 Jkt 000000 PO 00000 Frm 00026 Fmt 6633 Sfmt 6633 R:\DOCS\75601.000 TIMD
23 

ing your ideas with us today, and, especially to Ms. Olson and Mr. 

Brostek, a big, big ‘‘thank you’’ for all your help. 

Mr. BROSTEK. You are welcome. 

The CHAIRMAN. Thank you, Senator. 

Senator Thune? 

Senator THUNE. Thank you, Mr. Chairman. I want to thank our 

panelists for their suggestions, and hopefully this will be part of a 

debate about tax reform that will end up in us actually doing something about tax reform, because it is long overdue in the country. I want to ask a question. According to the GAO, of the $345 billion in the gross tax gap in 2001, the IRS ultimately recovered 

about $55 billion, or about 16 percent of the total. 

If we can estimate the amount of the tax gap, and we know the 

major areas where tax compliance is weakest, how do you explain 

the low recovery rate by the IRS? 

Mr. Brostek? 

Mr. BROSTEK. There can be many, many reasons for that. In 

some cases, it is simply the taxpayers owe, but they do not have 

the resources to pay. So there is certainly a significant amount of 

that. 

An awful lot of the compliance problems in the tax gap are in relatively small dollar amounts, and so it does not pay IRS to invest 

a lot to go after them. Those small dollar amounts can add up to 

significant amounts of money, but trying to figure out the costeffective way of going after that noncompliance is very difficult. 

Senator THUNE. If you look at the enforcement efforts by the 

IRS, only about 3 percent of the tax collection is a result of these 

efforts, while 97 percent, as I think has already been noted, is a 

result of voluntary tax compliance by taxpayers. 

Yet, we tend to focus, here in Congress, our discussions on enforcement. But considering that statistic, are there steps that the 

IRS could take in terms of customer service to improve the voluntary compliance component of this? 

Ms. Olson? 

Ms. OLSON. The IRS, in its strategic plan for 2009 to 2013, set 

a goal of increasing the tax compliance rate by a little more than 

2 percent. And based on how it is doing it by enforcement, to raise 

that kind of revenue and that compliance increase, it would have 

to increase enforcement revenue by 144-percent to get that increase. 

So it is clear to me that Congress is not going to fund us to get 

a 144-percent enforcement increase. 

The name of the game is taxpayer education, service, outreach, 

really working with groups and strategically using our enforcement 

resources for the right pressure point and getting indirect benefits. 

And I think then the complexity, where you get to taxpayer morale, that so much of, I believe, noncompliance is sort of what I call 

self-help. Taxpayers believe that somebody else is getting a benefit, 

and so they help themselves to some other benefit themselves. And 

if we can change that dynamic, we will get greater compliance. 

Senator THUNE. We have over 6 billion hours complying with the 

tax code every year, and I have seen the breakdown here of kind 

of what that translates into in terms of cost for the individual taxpayer, if you are a non-business individual taxpayer. 

24 

But what is the estimated cost to our economy of over 6 billion 

man hours being spent filling out tax returns that could otherwise 

be put to hiring more people or purchasing new pieces of equipment, something that would actually add to our country’s economic 

growth? 

Mr. BROSTEK. We did a study in 2005 surveying the literature. The best estimates that we found at the lower end were about $107 

billion per year of costs for complying with the tax code. That was 

both for individuals and corporations. 

Senator THUNE. And that is the low end. 

Mr. BROSTEK. That was the low end, yes. 

Senator THUNE. Well, that is a conservative estimate. It certainly 

suggests that there could be a lot of additional—— 

Mr. BROSTEK. Senator, can I come back to your earlier question 

for just a moment? 

Senator THUNE. Yes. 

Mr. BROSTEK. While I agree with everything that Ms. Olson said 

about providing better service, one of the important facts to understand about the tax system now is that only about 10 percent of 

taxpayers sit down with paper and pencil and do their returns. 

Sixty percent go to a paid preparer. 

Another 30 percent or so buy tax software to deal with the tax 

obligations that they have. That makes an important chokepoint 

here, the paid preparer community, making sure that they are 

well-educated and competent for their responsibilities, that they 

are very ethical in carrying out their responsibilities, and that the 

software packages that both the paid preparers and the taxpayers 

use are reflecting the tax code well in order to get good, high levels 

of compliance. 

Senator THUNE. If I could, very quickly, for Mr. Kirkham or Ms. 

Carpenter. I am interested in knowing, just in terms of the tax certainty—we all talk about economic certainty and knowing, having 

predictability in policy coming out of Washington so that you can 

plan at least around it. 

Can you discuss that aspect and how important it is in shaping 

your business decisions? And I guess what I am getting at is, is 

there a major difference between a provision of the tax code that 

lasts for a number of years, and elements of our tax code that expire or get changed on a year-to-year basis, because we have a good 

number of those that consistently are up for renewal, it seems like 

every year? 

Explain how tax certainty bears on your decision-making. 

Ms. CARPENTER. It is extremely difficult, because every year, it 

is a different game, and you never know if you really have everything in front of you. And like Mr. Kirkham said, you have to hire 

other people at extra expense to your business always, because it 

is beyond the comprehension of most small business owners like 

me. 

It is more than we have the resources or time to get through. So 

you do the best you can. 

Senator THUNE. Anything to add to that, Mr. Kirkham? 

Mr. KIRKHAM. I would just say that what is happening right now 

in the tax code is the tax code is driving our business decisions. 

Our business is not driving our business decisions. 

25 

So, at the end of the year, when we have a capital improvement 

and you guys give us a $200,000 write-off so we can buy a new 

piece of big equipment—a big CNC, computer numerator control— 

you know what? What if I wanted that money for something else? 

I cannot. 

Well, I am going to go buy a new piece of equipment instead, because, if I keep it, what happens? If I keep the money, I should say, 

I am going to get taxed on it. Well, I am going to go put it in a 

piece of equipment that I can write off. 

Maybe or probably or definitely, I could have used that money 

in a much better way that would have created more jobs. And I 

cannot say it enough, this whole discussion is about jobs. 

Senator THUNE. Thank you. Thank you, Mr. Chairman. Thank 

you all very much. 

The CHAIRMAN. Thank you, Senator. 

Senator Snowe? 

Senator SNOWE. Thank you, Mr. Chairman. And I want to thank 

all of our witnesses here today. Some of us recall the day when we 

had the 1986 tax reform that was supposed to be a simplification. 

So much for that idea. And here we are today, regrettably. And I 

understand your frustrations, Mr. Kirkham. I hear that all the 

time as ranking member of the Small Business Committee. I agree 

with you. 

This has certainly had a profound impact even on job creation 

and economic growth in this country because of the undue burden 

that the tax code has placed on small businesses and the ability 

just even to try to conform with the tax code. 

Ms. Carpenter, I appreciate you mentioning the legislation I have 

introduced along with the chair of the Small Business Committee, 

Senator Landrieu. I do think it is important to put you on par with 

the restaurant industry, and a point that you made and underscored is the fact that, unlike that industry, your employees can 

move to another employer and just rent chairs as a way of circumventing all of that. 

And so it does have a tremendous impact on your business, and 

hopefully we can get this done, because I think it is a matter of 

fairness. 

Ms. Olson, we really need comprehensive tax reform—and, I 

mean, I have argued for that for some time—in order to achieve 

simplification. But are there efforts that we can do now to help improve the situation for small business owners? For example, Ms. 

Carpenter talked about making it fair in terms of the tip credit and 

making the salon industry eligible for that. 

The 3-percent withholding on government contractors is another 

issue that Senator Brown has introduced, and I have joined him as 

a co-sponsor. That makes these contractors have to pay their liability up front. That is resulting in job losses, business loss, not to 

mention the fact of a loss of revenue. It is going to cost more to 

comply with that than the money that is intended to be raised by 

this provision that was enacted in 2005. 

So could you tell us what you think would be important in passing some initiatives that could make a difference for small business 

at this point in time? 

26 

Ms. OLSON. Well, there are two that go specifically—one, to the 

3 percent. One thing that we have advocated for a long time was 

that, instead of doing a withholding requirement on Federal contractors, you just make it a requirement that, before the contract 

is awarded, there be a review—is that entity in compliance with 

the Federal tax laws? 

And part of that can be, well, if you are not in compliance, what 

do we need to do to get you into compliance? It is a proactive approach. We do that in the Internal Revenue Service. 

For example, when I give grants to low-income taxpayer clinics, 

I do a compliance review and do not award that money if they are 

not in compliance or getting into it. That gets rid of that withholding, and it also puts the leverage on getting people into compliance. It is a positive thing. 

Another thing that we actually worked with the salon associations about was a recommendation that the law be changed so that, 

if you were going to categorize workers as independent contractors, 

then you could voluntarily do withholding on those workers. 

So, if someone rented a salon sink, a desk, then the salon owner 

would do some withholding on that person. And so, even if you did 

not categorize them as employees, you still got more of a level playing field there. And so we have worked on that legislation. 

Senator SNOWE. Well, it is interesting, because, obviously, this is 

a central piece and becomes even more profound because of where 

we are economically in creating jobs, and that is having a huge impact on small business. 

As you say, 94 percent of the noncompliance is with small businesses. It is unintentional, for the most part. 

So the question is, what we can accomplish in the interim if we 

cannot get comprehensive tax reform—which I think we could, 

frankly, if we put our minds to it and work on it now as opposed 

to years down the road when it makes a huge difference in terms 

of the economic environment. 

Now, the health care law is a good example. We passed a small 

business tax credit that was scheduled to go into effect in 2010. An 

accountant in Maine, it took him 9 hours just to determine whether 

or not he was qualified for this tax credit. 

Now, that was an accountant for himself determining whether or 

not he was qualified. I mean, here is another example of absurd 

complexity when it comes to the tax code. It is unnecessary. 

But, frankly, it is our responsibility to make sure, when these 

types of initiatives are passing Congress, we should be responsible 

in terms of how to implement them and how they take effect. 

Are you aware of that complex tax credit? 

Ms. OLSON. Yes. And my office actually has been developing a 

calculator. Actually, one of my employees in the Montana local taxpayer office did it in his spare time. But we have adopted it, and 

we are trying to test it right now so we can get the IRS to put it 

up on the website. 

So, if you just plug in certain numbers, the algorithms will do 

the rest of the calculation. But it is very complicated, and it may 

be, as Mr. Brostek pointed out, that software might get a different 

answer from what we get, because the calculations are so complicated. 

27 

Senator SNOWE. Do you think that we could achieve even a modicum of simplification if we were to at least identify those issues 

that could make a difference for small businesses and individuals? 

Another initiative that I have joined with Senator Enzi on is conforming the tax information on subchapter S and C corps, verifying 

that information at the same compliance date. 

Ms. OLSON. I think there are a lot of things, a lot of individual 

proposals, where you do not have to have comprehensive tax reform. The only point I would make about comprehensive tax reform 

is, then you are looking at the whole picture so you do not create 

some gaps that then lead to more provisions later on to close those 

gaps. 

Senator SNOWE. Yes. I do not disagree with you. I am just wondering if, in the meantime, there are certain things that we can 

identify, and we should readily do so, because it is just affecting 

job creation. I think that is the bottom line here. And it would give 

great impetus, I think, to help those who are struggling, frankly, 

and I think that that is something that people do not easily recognize here in Washington, inside the Beltway, about what is detrimental to job creation. 

I think Mr. Kirkham expressed that frustration very eloquently, 

as well as what Ms. Carpenter is experiencing in her own salon because of the inequities in the tax code. 

So I appreciate your testimony here today. Thank you. 

Senator HATCH [presiding]. Thank you. I want to personally 

thank all of you for testifying here today. I thought the testimony 

was very, very good and very informative and illuminating, because 

it is apparent that this committee has to start doing its job. I am 

not blaming anybody on the committee, I just want to say that 

we—I think that is why we are holding these hearings, and I want 

to commend the chairman for doing so and bringing good people 

like you in to testify before us. 

We simply have to change this tax code, and we have to change 

a lot of other things in our society, as well. It is a shame that the 

greatest society in the history of the world is in danger of failing 

because we are unwilling to do our job here. 

So I just want to thank each of you for taking time out of your 

busy schedules to be here and to testify. I do not think your time 

has been wasted at all. 

So with that, we will recess until further notice. 

[Whereupon, at 11:35 a.m., the hearing was concluded.] 

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