Restate the Tax Code, Along With H&,R Block Profit

March 8 (Bloomberg) — "In your corner" is the motto of H&R Block Inc., but maybe it needs someone in its corner.

The company last month reported that it made a $32 million error on tax documents for fiscal years 2005 and 2004. A further embarrassment — at least for management —was H&R Block's announcement that it may make yet more restatements in future.

The company's stock has been dropping since last July, well before the restatements. Its problems are not merely standard business troubles. On top of being the largest U.S. income tax preparer, H&R Block has long been a kind of national barometer for the tax culture. Its troubles tell us that our tax culture has troubles as well.

Consider the record. Twenty years ago President Ronald Reagan joined both Democrats and Republicans in Congress to write their great tax cut. The law created a low top rate of 28 percent, but also simplified the tax code significantly. One of the principles of the 1986 Act was that the tax code emphasize revenue collection as opposed to economic redistribution or social projects. Most involved thought the more transparent law would limit cynical tax games and increase civic trust.

At the same time, lawmakers in both parties were reconsidering the earned-income tax credit, an offset for other taxes designed to persuade very low earners to stay in the workforce. Paying people to work seemed better than paying them welfare.

Way of Life

From a small child-related program, the EITC morphed over the years into a way of life for tens of millions of people. Instead of merely serving as an offset, it soon went further, paying back more in rebates to individuals than they had ever paid in the first place.

Other changes brought greater complexity. The 1997 tax law, for example, established 11 different tax rates for capital gains. In 2004, the Cato Institute's Chris Edwards counted more than 60,000 pages of tax law in the official tax code, regulations and Internal Revenue Service rules. That was up from 40,500 back in 1995.

Republicans were just as bad as Democrats. Between 2000 and 2004, Republican Washington increased the number of tax loopholes for education and training to 28 from 16. There's something in the DNA of social conservatives that makes them want to produce not only children, but also child-tax credits.

In any case, all this new law did for tax preparers what Sarbanes-Oxley has done more recently for corporate accountants. The rate of reliance on professional preparers rose, and one of the great beneficiaries was H&R Block. Storefronts opened by the hundreds to serve the lower earners who collected the EITC.

Refund Loans

H&R Block even developed a business — and other tax preparers followed — of advancing taxpayers both their EITC and their regular refunds early, for a fee. The IRS went along, even though customers who took the advances were being charged interest for money that was theirs in the first place. Share prices of tax preparers climbed, nicely paralleling the increasing complexity.

And for a long period there were many — especially at H&R Block — who argued this was as it should be.

Years ago, founder Henry Bloch told me that complexity was virtuous — indeed, that tax complexity correlated to tax fairness.

As for the EITC, it became the emblem of 1990s progressives, and the beloved object of study by think tank tax departments. Where Lyndon Johnson had the Great Society, Bill Clinton had the EITC. The proof of a good government was its willingness to take new steps to reduce the tax burden of lower earners. Just this month H&R Block announced it was participating in the William J. Clinton Foundation "EITC awareness program."

Visible Limits

Lately, the limits of this model have also become visible. For one thing, lawmakers have cut the taxes on lower earners so much that they have scarcely anything left to cut: the bottom half of all earners pay less than 5 percent of the nation's income tax. For another, whatever tax breaks the code gives the low earners come at the expense of middle earners, who get snared by that modern gizmo, the alternative minimum tax. They confront increased tax bills.

H&R Block and its closest competitor, Jackson Hewitt Tax Service Inc., have recently fallen into a war over the refund market. Jackson Hewitt created a program called "Money Now," which lets workers who couldn't wait for the W-2 to arrive in the mail to collect a loan against their future refund by simply supplying a pay stub.

Tax Lottery

H&R Block has been countering with a genuine lottery: the "Double your Refund Instant Win Game" aims to build customer loyalty. "I bought a car and paid off most of my bills," winner Dorothy S. of Big Spring, Texas, reports on the company Web site.

At a time when we are experiencing the lottery-ization of everything, the lottery tax return is perhaps not so surprising. Still, gambling while filing taxes is pretty far from what the old reformers had in mind.

Some analysts say they believe the trend toward using professional preparers may be maxing out. Michael Millman, an analyst at Soleil Securities in New York has a "sell" recommendation on both H&R Block and Jackson-Hewitt.

The tax preparers now are paying their penalty for cynicism and sanctimony. When will the lawmakers pay theirs?

(Amity Shlaes is a Bloomberg News columnist. The opinions expressed are her own.)

© Copyright 2006 Bloomberg

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