THE GUARDIANS OF THE NEW INTERNAL REVENUE CODE.

• Author: Michael, Douglas C.

1. INTRODUCTION 696 II. COMPLEXITY IS HERE TO STAY 699 A. The Old Complexity 700 B. The New Complexity 703 III. THE DEVELOPMENT OF THE TAX RETURN PREPARATION SOFTWARE INDUSTRY 710 A. Development of E-File Technology 710 B. The Free File Alliance 714 C. The Developing Relationship Between Government and Private Industry 721 1. Existing Regulation 722 2. Attempts at Extending Regulation 724 IV. THE GOVERNMENT'S ROLE IN THE NEW CODE 725 A. Creation of a Co-Regulatory System 726 1. Creating an Effective Industry Regulator 728 2. Creating an Effective Self-Regulatory Organization 731 B. Credible Residual Regulation 736 V. CONCLUSION 739 [T]he United States tax administration runs on rules, both those embodied in the law and those coded into computers. It is the latter that can have a tremendous impact on the structure of tax laws.... Tax administration is no longer so much about individual employees administering the law to other individuals; it is much more about individual employees monitoring machines. (1) I. INTRODUCTION

   Electronic filing (or e-filing) of federal income tax returns is a permanent fixture of life for taxpayers in the United States. However, it is not just the e-filing which is remarkable, but also the number of taxpayers who have decided to take the law and the e-filing software into their own hands. The following table shows the number of individual tax returns filed each year, with the breakdown in the percentage of returns e-filed by taxpayers using a tax professional and by taxpayers alone. (2)

   We can see that most of the increase in e-filing is coming from taxpayers making their own efforts without the assistance of a tax professional. The Covid-19 pandemic dramatically accelerated this trend in tax year 2019 (filing season January-November 2020), so that tax year 2020 shows a small reversal. Regardless of who prepares the return or how it is filed, nearly all individual federal income tax returns are completed with the assistance of return preparation software (RPS). (3) As all Americans become users of ubiquitous technology, we can expect RPS use to become universal. (4) "If tax compliance were an industry, it would be one of the largest in the United States." (5)

   Thus, there exists, especially for individual taxpayers, a new Internal Revenue Code. It is not the legal code written by Congress, but the computer code written by private RPS companies. (6) The IRS observed as early as 2009 that "[tjhe tax software industry has fundamentally changed the means of compliance with our civic tax obligations." (7)

   To be sure, this new Internal Revenue Code yields dramatic advantages for both individuals and the IRS. The combination of computer preparation and electronic filing benefits individuals by eliminating the need for paper filing, reducing processing time and increasing accuracy, all while maintaining the security and confidentiality of the information. The new code benefits the government by dramatically reducing return processing costs, (8) and the lower error rate further reduces investigation and follow-up costs. (9) E-filing also "lays the groundwork for further improvements in tax administration because it captures 100 percent of the information on returns in a digital fashion," rather than the small fraction of that information coded from paper returns. (10)

   Despite these clear advantages, the new Internal Revenue Code has two unintended consequences deserving further discussion and study. First, there will now be unremitting and unstoppable growth in the complexity of the Code. Second, there is substantial discretion and uncertain reliability in the new Internal Revenue Code, as the IRS has delegated development and maintenance to private industry. Part II examines the impact of computers on tax complexity, how the new Internal Revenue Code is destined to remain complex, and the implications for tax policy. Part III describes the development of e-filing and the return-preparation industry. Part IV discusses how the federal government can, with private industry partnership, properly control and oversee the new Internal Revenue Code, to perhaps limit these unintended consequences of electronic filing and to ensure that the benefits of e-filing continue to outweigh the costs.

2. COMPLEXITY IS HERE TO STAY

   The complexity of the federal income tax system is an enduring topic of scholarly debate. (11) On the one hand, complexity has its costs, which are clear, measurable and reducible. Estimates of compliance costs vary and are difficult to prepare, (12) but they range in the hundreds of billions of dollars. (13) On the other hand, complexity alone is not an evil, and making taxes simpler is not necessarily a laudable goal standing alone. Simplicity may be a byproduct of meaningful tax reforms which produce efficiency or equity. Or, more fundamentally, "on fuller reflection, it appears that simplification is a hopeless cause--that it lacks a constituency; is fatally at odds with other, more important, goals of tax policy; is impossible in a complex society; or is simply unimportant." (14)

   Complexity takes on a new dimension with the new computer-based Internal Revenue Code. First, I consider the traditional aspects of complexity which are particularly relevant in discussing the new Code. Second, I discuss the new aspects of complexity which result from the new rules residing in computer code instead of laws.

   1. The Old Complexity

      Everyone who has studied the issue recognizes that, while there are places where clear gains could result from simplification, overall tax complexity is here to stay. (15) In the Revenue Restructuring Act of 1998, (16) Congress required that annual reports be made to it by the IRS Commissioner on the "sources of complexity in the administration of the Federal tax laws." (17) Despite this command, "the IRS has issued only two such reports and none since 2002." (18) The number of IRC sections, subsections, and cross-references has doubled since 1991. (19) Three major presidentially-appointed study groups have made comprehensive recommendations on tax simplification, but none have evoked legislative response. (20) There are three aspects of complexity especially relevant to thedevelopment and ascendance of the new Internal Revenue Code--the computer code of RPS.

      First, the Code is subject to constant amendment. (21) This process is explained in part by the demand of well-financed constituencies for legislation. (22) In addition, such law writing is done without careful consultation with technical writers. (23) This ensures that there will be a steady supply of errors in and modifications to the law, and that they will rarely (if ever) be drafted or passed in a manner which is optimal from a technical implementation standpoint. Neither Congress nor the IRS will or will be able to do this job; therefore, it will fall to the RPS industry.

      Second, the Code is used as the vehicle for many tax expenditures, but importantly for large social programs, such as the Earned Income Tax Credit (EITC) and the Child Tax Credit (CTC). Both have evolved in greater complexity and coverage since originally introduced. (24) They were a key part of the most recent economic assistance provisions of the American Rescue Plan Act. (25) Thus, the consistently complex Code will be used to deliver benefits to a population generally unable to understand those benefits without assistance of RPS or a preparer who uses RPS. (26)

      Finally, the federal income tax is levied upon complicated economic entities and situations. As others have observed, the tax code is complicated because life is complicated. (27) So long as the tax is levied on income, it will continue to be complicated. And because the income tax remains the primary method of financing the federal government, (28) it is thus almost guaranteed, absent some political and economic sea change, that the increasingly complex income tax will continue to have a major impact on most Americans' lives.

   2. The New Complexity

      But there are three other reasons for the enduring complexity of the tax system which have more to do with the existence of paid preparers and RPS. These reasons also have different implications for tax policy than do the traditional concerns about complexity.

      First, RPS has reduced the overall costs of complexity at the margin. Taxpayers no longer need to figure out how the tax law applies to their situations nor make the increasingly detailed calculations required for items of income, deduction or credit. (29) Complexity simply isn't an issue for them. (30) There is no political or policy value in tax simplification anymore. (31) No taxpayers (and few practitioners) need to know or care about the forms and instructions prepared by the IRS, (32) and many may remain ignorant of the laws themselves. It is safe to say that tax forms (and instructions) may fade into irrelevance as most taxpayers turn to RPS regardless of how they file their returns. (33) The new Internal Revenue Code has virtually no limits to its complexity. In a 2003 article, Prof. Samuel Donaldson observed that tax complexity is different from other legal complexity (such as bankruptcy or torts) because hundreds of millions of Americans encounter the tax laws, and because the tax laws require taxpayers to police themselves. (34) This encounter is a softer experience now than over a decade ago. Both taxpayers and the government have come to rely on RPS as a critical piece of the machinery ensuring compliance with the tax laws.

      Second, and somewhat conversely, complexity remains a major issue for many low-income taxpayers. Low-income individuals do not have returns which they consider to be "simple." Because the tax system is used to deliver benefits through major tax expenditures, (35) low-income taxpayers are driven by the resulting complexity to paid preparers and computers. (36) This can create an additional problem for low-income taxpayers...