Tax Preparers Shouldn’t Get IRS Favors

Taxes are big business. And not just for the federal government, which collects over $1 trillion per year in income tax revenue alone.

Because the tax code is complicated — it's more than 70,000 pages long — most taxpayers pay someone else to do their taxes. The tax preparation industry has grown into a full-fledged special interest. And now it's working with the IRS to benefit itself at consumers' expense.

Proposed regulations recently published in the Federal Register would require all tax preparers to pass an examination to become "registered tax return preparers." There are already about 46,000 registered tax preparers under current regulations. But this new rule would require all tax preparers to register with the IRS. It would be illegal for a tax preparer to work without a valid preparer tax identification number, or PTIN.

Since the IRS has the power to revoke registrations, tax preparers will have to be careful not to advocate too aggressively for their clients. Besides this chilling effect, mandatory registration reduces consumer choice.

There are at least 600,000 unregistered preparers. Many of them are retirees. Others have jobs, but prepare taxes on the side to help make ends meet. Still others are volunteers. They give their services for free to people who can't afford a tax preparer. How many will give up, rather than jump through the proposed regulatory hoops?

The IRS estimates the total cost of the new regulations at $48.5 million, plus 1.71 million hours of paperwork and record-keeping burdens. That's equivalent to 855 full-time jobs — and not the kind that will spark an economic recovery.

The extra burden doesn't matter so much to larger tax preparation firms. They have economies of scale and professional administrative staff to help them handle the load. But individual tax preparers and smaller firms don't. Larger firms are using regulation as a weapon to freeze out smaller competitors.

Similar stories play out across the economy. Economists Nicole V. Crain and W. Mark Crain found that big firms — with more than 500 employees — pay $7,755 per employee per year to comply with federal regulations. Their smaller rivals have to pay a whopping $10,585 per employee per year. That's a built-in competitive advantage of nearly $3,000 per employee, courtesy of Washington. No wonder so many businesses have D.C. offices these days.

H&R Block alone spent nearly $1 million on lobbying in the last half of 2009, much of it pushing for these very tax-preparer regulations. It wants the deck stacked even further in its favor.

The other big competitor for large tax preparation firms is software, such as Intuit's TurboTax. New regulations for that are in the early stages right now. Maybe those rules will hobble software companies to favor traditional tax preparers. Maybe established software giants like Intuit will use the rules to handicap smaller rivals and pesky startups. Whatever the result, it won't be pretty for consumers.

Consider one more competitor to the competitively priced help that tax preparers provide: the IRS itself. The IRS's own Taxpayer Advocate reported in January that the agency has set a goal of answering a mere 75% of the phone calls it receives. In 2008, the agency didn't answer nearly half its phone calls.

Getting information out of the IRS by mail is no easier. The Taxpayer Advocate found that the agency's "correspondence inventory rose from approximately 480,000 at the end of FY 2007 to almost 776,000 at the end of FY 2009 — a 62% increase."

All this has occurred as the IRS has dramatically increased spending on enforcement measures. Spending on services to taxpayers has declined over the same time period.

The best solution to this problem is simplifying the tax code. There is no legitimate reason for the tax code to be so complicated that most people have to turn to others for help.

Short of that, the IRS should resist industry's plea to be regulated. That agency has more than enough on its plate as it is.

Companies such as H&R Block grew big because they are good at what they do. But if the IRS artificially tilts the competitive process in their favor, they won't have to stay good to stay big. When companies compete in the marketplace, consumers win. But when they instead compete in Washington, the result is, well, taxing.

• Young is fellow in Regulatory Studies at the Competitive Enterprise Institute.

• Brown is a researcher at the Bluegrass Institute.