U.S. government should ask a group of tax software firms to propose a simplified 100% e-filing and e-payment tax structure?

Not everyone owns a computer.

W said: Not everyone owns a computer.
With the savings in cost and time, everyone could afford a PC or local government could provide access to one, helping make U.S. achieve 100% computer literacy rate in a few years.

I say that tax simplification is a bad idea. The US Tax code is a large and complex social engineering experiment, and by many measures it works very well.

It promotes home ownership, because this tends to promote better citizenship. It reduces the cost of having children, because this tends to ensure more future citizens. It promotes personal charitable contributions, because this tends to reduce government spending. It promotes personal savings, because this tends to provide capitol to enhance the economy. In its most unsung benefit, it helps poor people so fewer feel they must resort to crime to survive.

Tax simplification would reduce or eliminate some or all of these benefits. That is a bad idea just to simplify the tax code.

Dan T said: I say that tax simplification is a bad idea. The US Tax code is a large and complex social engineering experiment, and by many measures it works very well. It promotes home ownership, because this tends to promote better citizenship. It reduces the cost of having children, because this tends to ensure more future citizens. It promotes personal charitable contributions, because this tends to reduce government spending. It promotes personal savings, because this tends to provide capitol to enhance the economy. In its most unsung benefit, it helps poor people so fewer feel they must resort to crime to survive. Tax simplification would reduce or eliminate some or all of these benefits. That is a bad idea just to simplify the tax code.

You are combining social welfare programs with the tax code. Simplifying the tax code will allow collecting taxes efficiently. Focus of social welfare programs will still be on implementation of such programs efficiently.

It promotes home ownership, because this tends to promote better citizenship.

While there may be correlation between home ownership and good citizenship it is not clear that there is causation. Furthermore, it is not clear that those few people who choose to own a home because of tax regulations actually become better citizens as a result of being compelled to make that choice.

It reduces the cost of having children, because this tends to ensure more future citizens.

Any argument for a higher birth rate is also an argument for a higher immigration rate. If the USA wants more citizens it can get all the citizens it wants by opening up it borders with other countries.

It promotes personal charitable contributions, because this tends to reduce government spending.

Right. The war in Iraq was supported primarily by charitable contributions. My experience has been that most "charitable" contributions are actually to things like political advocacy that don't offset government spending.

It promotes personal savings, because this tends to provide capitol to enhance the economy.

It also discourages personal savings by taxing the savings and imposing complex accounting rules. There are a number of investments that I was tempted to make that I decided not to make because I didn't want the hassle of calculating the taxes I would owe. In fact, one of the main reasons I haven't opened up a specific retirement account is that it would make my taxes too complicated.

In its most unsung benefit, it helps poor people so fewer feel they must resort to crime to survive.

This, I sort of agree with. Pure capitalism results in a distribution of wealth where a few people are very rich and everyone else is very poor. Such a wealth distribution is very inefficient and basically destroys an economy. One of the key purposes of taxes is to prevent the economy from progressing to this extreme distribution.

Having said that, tax complexity really has nothing to do with this. It is entirely possible for a very simple tax system to redistribute the wealth efficiently. The one thing a complex tax system does is confuse people but it is not clear that this makes the wealth redistribution any easier.

To paraphrase someone famous, complexity has a thousand fathers while simplicity is an orphan.

The best window for real tax reform was when President Bush took office at a time of large budget surpluses. Concurrently, the Joint Committee on Taxation prepared a detailed report on recommended measures to simplify the Code. The measures would have cost significant amounts of revenue to implement -- the largest cost being the elimination of the AMT. Unfortunately (in my own view), the Bush Administration chose a tax reform package that ignored most of the Joint Committee's recommendations and that actually made the Code several times more complex due to the sunset provisions. (As a footnote, these sunset provisions allowed the reform package to be exempt from filibuster and pass the Senate with a mere majority.)

Unless we can somehow restrain Federal spending, the opportunity for passage of those recommendations would appear to be lost.

Wasn't it B. Franklin who said, "The only sure things in life are death and taxes." Or as some wag put it, "The end of all political activity is to get the money out of the public." As life and society has grown more complex, so has the tax codes. If we wish to simplfy the tax code and hence make it more efficient, perhaps we need to make "life" more simple. Anyone willing to go back to the caves and savannah?

I wonder how much tax compliance cost is created by taxing capital income, especially capital gains. Labor income is much simpler, for most people (the self-employed being exceptions). If capital income were untaxed, that would also eliminate the need to tax trusts, another saving, and to keep track of what state-bond interest is exempt from federal taxes.

The other big item to look at in reducing compliance costs is record-keeping for expenses. If it were costless to keep records (and to verify them), then all income-generating expenses should be deductible. Since it is not, maybe even major expenses such as home offices and the use of vehicles should not be deductible-- as well as the more dubious hotel, food, and entertainment expenses.

Eric Rasmusen suggests exempting taxes on capital because it may be costly to tax. Isn't it simpler to exempt labor? After all, most people have no or trivial capital gains; by exempting labor from tax we can create a tax system which only taxes those well positioned to cope with the unavoidable costs.

I was a bit surprised by Posner's glib defense of the "compelling economic justifications" for many complexities in the tax code. Much of the complexity, from my seat, seems to derive from classic lobbying by small minorities for their advantage to the detriment of the majority. Surely an overwhelming simplification would have the advantage of levelling many of these advantages (which are unlikely to be economically efficient)?

Why don't we just get rid of taxes and money and give everyone a gun and fifteen bullets.

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There was once a scheme to get the Government: Fed, State, County, and Local to go over to using a "zero based budgeting scheme" in order to get the annual budgeting increases under control. That fell by the wayside. Then there was the scheme to create a progressive tax scale as opposed to the current regressive scheme now in use; by eliminating all loopholes and deductions and establishing a graduated tax rate based on income for all individuals (corporate and private). That also went up in smoke.

I guess it just goes to prove that no one wants to give up their perq's. and deductions. Like the old song goes, "Keep your hands off my stack!" "It's mine, mine, mine!" Ah, is greed really all that good?

Sometimes it may be best to forget what I have seen in my 30+ years of dealing with federal taxation.
We actually got painfully close to "paperless" returns for the vast majority of taxpayers(90%or so). We could still get there. Raise the standard deduction so that it takes a big mortgage to justify itemization and scrape all the nutty credits (including Earned Income.) Most people don't have dividend income or capital gains. (They realy don't.) Do this and we are back to a 1040A on a old fashion IBM card. (Believe me, I have filed a tax return on an IBM card.

The tax code is quite efficient. All sorts of goodies are in there, that save all sorts of people cash. Not you, perhaps. But someone. And that someone was given cash by their representative in Washington. Every provision of the tax code is proof of a political deal. Politicians exist to allocate resources, and the tax code is the Rosetta Stone of it. The tax code is quite efficient at what it exists to do, which is distribute goodies to the people who bothered to vote. I voted, so I love the tax code.

The reason the tax code hasn't taken any of the forms suggested here is that people don't want it; what people want is what is in the tax code. People complain about agricultural subsidies all the time, but they are there for a reason: and there are people in Iowa who love the IRS.

Tax preparation fees are subject to the limitation on miscellaneous itemized deductions and thus are not deductible for the overwhelming majority of individual taxpayers. So this "reform" has been implemented.

I'm pretty skeptical that simplification will produce much in savings. The bulk of our tax preparation time goes into determining investment income, e.g., tracking basis, not computing deductions. (Maybe charitable deductions take a little time, but anyone who wants to can eliminate that problem by giving their entire charitable donations for the year in one lump sum to their church or the United Way or whatever.)

Deductions were originally rationalized as necessary to tax individuals only on income that was truly disposible or a source of discretionary expenditures. Charitable giving was regarded a duty, and a reduction in such income.

Policy-based deductions that reduce the government's tax receipts can be seen as government expenditures to promote a policy.

To truly measure the costs of our tax system, wouldn't one need to measure the inefficiencies of such "tax reduction expenditures" as the mortgage interest and charitable deductions? Tax preparation costs are only one component of the inefficiency.

This isn't an original idea; Walter Blum discussed it at length in his income tax classes and had considerable data on this subject. Are scholars still trying to calculate these inefficiencies?

wes -- a retirement account is too complicated for you to bother??? It is one entry and one simple substraction. Get real.

But I know no one on principle that opposes tax simplification for everyone. But everyone is also fearful of losing their pet deduction.

We have met the enemy, and it is ourselves.

Posner talks about simplifying the tax code to reduce distortions on the market. What about using the tax code to correct other distortions? I think the biggest and most obvious one is to tax activities that create negative externalities such as the generation of pollution.

wes -- a retirement account is too complicated for you to bother??? It is one entry and one simple substraction. Get real

OK. Let's look at a very simple example. Let's say that at some point in the future I need to take out a loan for a house or a car or my kids college tuition or medical expenses or something. Loans are expensive and any money tied up in a retirement account is money I will have to borrow at substantial cost to myself or incure complicated tax penalties.

If, as you assert, retirement accounts are trivially simple, then give me the explicit mathematical formula for the net fincial impact of a retirement account (taking into account tax benefits from the retirement account and interest paid on the loan). Include all relevent variables such as my expected salary, expected interest rates, expected inflation rates, performance of the stock market, foreign exchange rates and the prices of houses, cars, college tuition, and medical services over the course of the retirement account (that is, over my lifetime).

Furthermore, for those variables that are beyond my control, such as interests rates and even to some extent my employment prospects, provide an explicit formula predicting what these will be over the course of my lifetime. Note that for any of this to be meaningful you must be able to predict all the relevant variables with a high degree of certainty.

Wes: Let's say that at some point in the future I need to take out a loan for a house or a car or my kids college tuition or medical expenses or something.

There are different kinds of retirement accounts. However for a Roth IRA, note there is no early withdrawal penalty if you are withdrawing the money to pay for a first-time house purchase, or for your kids college tuition, or for medical expenses which are more than 7.5% of your income.

There is no "car purchase" exemption. However there is still no early withdrawal penalty as long as you are only taking out money you put in (as opposed to the tax-shielded earnings of that money). You could purchase a perfectly good car with a retracted IRA contribution.

Wes: Note that for any of this to be meaningful you must be able to predict all the relevant variables with a high degree of certainty.

No, you do not need a very good estimate of how likely various scenarios are to conclude that you are better off with a retirement account in almost every realistic scenario.

Wes,

The tax code does not at all complicate saving for retirement. What it does is offer a number of tax-advantaged options.

There is no requirement that you set one up. You are perfectly free to save for retirement in a regular investment account. You forgo the tax advantages but avoid the tax complications you seem to fear. You can withdarw money without penalty for any purpose at all, and face none of the problems you describe.

It is just wrong to say that the option of having a special retirement account complicates retirement savings.

Of course Richard Mason is correct that you are almost certain to be better off by using a tax-advantaged account, but nobody is making you.

There are different kinds of retirement accounts.

That's what's nice about the tax code - it's so simple.

However for a Roth IRA, note there is no early withdrawal penalty if you are withdrawing the money to pay...

There is both an early withdrawal penalty to consider and also a possible tax on earnings.

...for a first-time house purchase,...

But only up to a lifetime maximum of $10,000 and last I checked homes cost a lot more than $10,000. Not only that but there are addition restrictions. There are requirements that the IRA has been open 5 years and "first-time home" actually means "has not owned a home for two years" so anyone the moves frequently is out of luck. Furthermore, only qualified expenses can be counted so paying off a mortgage is also out.

...or for your kids college tuition,...

This avoids the penalty but not the tax on earnings so this is at best neutral.

...or for medical expenses which are more than 7.5% of your income.

Right. I (or perhaps some relative) get hit with a major illness and the first thing I want to do is wade through massive tax regulations to see which expenses (and which relatives) qualify and if I somehow mess it up and deduct an ineligible expense then I could be thrown in jail or, at the very least, subjected to even more bizarre and complicated tax regulations. Thank you IRS.

No, you do not need a very good estimate of how likely various scenarios are to conclude that you are better off with a retirement account in almost every realistic scenario.

OK. Let's do some numbers. Let's assume that I end up with a Roth IRA that has $20,000 of earnings that are not eligible for early withdrawal. Let's say that because of this I have to take out a $20,000 loan at 10% for 10 years instead of merely losing 5% interest per year by using my savings. This is a net loss of 5% per year.

By keeping the money in the IRA, I avoid a one time tax of roughly 20% on the $20,000 so I save $4,000 but then I lose $1,000 per year for 10 years on the loan for a total of $10,000. In the end I have lost $6,000 by opening the Roth IRA.

This is hardly an unrealistic scenario. Maybe I haven't lost my shirt in this example but it does show that it is far from certain that opening an IRA is a good idea. Furhtermore, once the time to ensure proper compliance with all the many applicable tax laws is factored in, opening an IRA starts looking even worse.

There is no requirement that you set one up. You are perfectly free to save for retirement in a regular investment account. You forgo the tax advantages but avoid the tax complications you seem to fear.

Whether there is a net financial benefit once loans and investing constraints are factored in, I agree that people who open IRA's probably do usually pay less tax than people who don't open IRA's. This is, however, as much a penalty inflicted on the people who would rather have simpler taxes as it is a benefit doled out to people who would rather have more complicated taxes.

Putting on my cynical hat, I suspect that the vast majority of people lack the skills and the time to accurately calculate the financial consequences to themselves of opening an IRA. It may be that, on average (whatever that means), there is a net financial benefit to opening an IRA. My suspicion, however, is that most people do so for emotional rather than rational reasons.

The careers of both investment advisers and loan officers are advanced when people lock themselves into IRA's. As a result, a situation has arisen where people are ushered into luxurious offices that are designed to reflect affluence and security and they are then told that the affluent and secure choice is to open an IRA.

Having rules to follow - from the authority of the federal government, no less - makes people feel secure. Blind obedience to authority is validating for many people. By following the rules, people affirm their place as an law obiding members of society.

I was initially shocked when a substantial fraction of the posts this conservative leaning weblog were in favor of a complicated tax system. The more I think about it, the more it seems to reflect the conservative desire for obedience to authority.

The cost of dealing with the IRS's attempt to bully and extort more money from taxpayers with audits that find a "small print" rule that was overlooked costs taxpayers untold grief and time. Often, the audit focuses on a technicality which has little bearing on whether or not the item in question was calculated in good faith and should or should not be allowed. Most audits on honest citizens cost far more than they bring in and are an excuse to justify the large and overbearing IRS workforce. Random audits are necessary, but too often they focus on topics that have no bearing on the integrity of the original tax return. For example, how can one justify the time and expense to the IRS (and the American public) to notify someone (a neighbor of mine) that he owes $23 more dollars in taxes, when he has already paid more than $30,000 for that year? How stupid! What a travesty! What a farce!

I was initially shocked when a substantial fraction of the posts this conservative leaning weblog were in favor of a complicated tax system.

Well, I'm not a conservative, but I have a response to this anyway. I do not favor a complicated system, but I disagree with the people calling for drastic simplification for two reasons.

First, the current system really isn't that complicated. Despite all the complaints and whatnot, the fact is that filling out a tax return should be, for most taxpayers, a simple task. Those who are overwhelmed by the job of doing three or four pieces of simple arithmetic and then looking the result up in a table aren't going to be able to manage under a different system either.

Second, I don't really believe that a replacement system would be any simpler. Read Becker's post. The complexities are there because of the political process, not because some wizard figured out that they were components of the perfect system. The exact same thing will, I think, happen with any reform. There will always be choices to be made, arguments for this or that treatment, and lobbying and maneuvering. I simply do not think that new tax legislation will come out of Congress significantly simpler than what we have, or that it will stay that simple even if it starts that way.

Many interesting comments. They will not be implemented, because they all belong to one of two categories. They represent either a real or perceived self(or group) interest, or they are an expression of an individual's or group's concept of "fairness". Since they are inherently divergent, not only that we cannot satisfy all, but as time goes on , they will become more numerous and divergent as the concept of both "self interest" and "fairness" will expand in both in number and scope. In my mind , the only solution to the problem is to stop looking at the Government - and taxation with its most visible manifestation - as some omnipotent parent that we can demand either dispensation from chores (taxes), or distribution of goodies in the name of "need" or " fairness". In my mind the only way to look at the Government as a giant service organization, which is entitled to receive compensation from the beneficiaries of the services it provides . For example it provides a free and democratic political system with an independent judiciary and national defence. This benefits everybody, so everybody should pay some taxes. It provides a very elaborate system of protection for private property, so owners of private property should pay for for this protection. The payment(or taxes if you like) - like an insurance premium - should be proportional to the value of the assets being protected. We have an elaborate system of consumer protection,- the FDA is probably the most expensive example - so a consumption tax is a legitimate charge for services provided. The hardest time I have is to come up with a similarly good justification for the income tax - other than it is easy to collect-.

I have gone back and forth as to whether I should go back to school and get an LL.M. in tax (that's an advanced law degree for those who may not know). Crazy as it may sound, the complexity of tax law is challenging and somewhat "fun." It's a technical area of law so clients don't try to second-guess you with "Well I was watching Boston Legal the other night and this guy got a $1 million when someone sneezed on him."

The other half of my brain realizes that the money spent on compliance could be better used for other purposes.

And therein lies the problem. I think the current tax system is entrenched - too many people depend on the complexity of the tax code on their livelihoods to create an incentive to change. I'm on the edge of being one of those people. I once heard from a CPA who favored tax simplification that he would gladly wash dishes for a living if the tax simplification meant eliminating his job. Yeah, right.

Wes,

I can only see four things wrong with your IRA-is-bad scenario.

1. You are confusing the early withdrawal penalty with the payment of tax. You might owe tax when withdrawing early from an IRA, but then you would owe tax on the same earnings (and perhaps earlier) if you had never had an IRA at all. The only thing that an IRA could possibly cost you is the 10% early withdrawal penalty.

2. Suppose that indeed you could have a net savings of $10,000 in interest by spending the $20,000 from the IRA. Then you should certainly do so. Again, the most you can have lost compared to never having the IRA is the $2,000 withdrawal fee: not $6,000 or $10,000 or any such miscalculated number. You are confusing the act of opening the IRA with the act of irrationally keeping money in the IRA even when circumstances make it unprofitable to do so.

3. Your scenario supposes that you are withdrawing IRA earnings, and therefore presumably all IRA principal and all your other savings, in order to make an unspecified non-emergency purchase, perhaps of a house. Spending every penny of your savings is itself risky and not necessarily advisable. Realistically, it would probably be a better idea to keep the IRA earnings in reserve against the possibility of a genuine emergency, such as serious illness or disability.

4. You are ignoring the time value of money. Even if you have to pay tax on IRA earnings, because of early withdrawal, you may have postponed that tax for several years. A tax postponed is a penny earned. Depending on the nature of your investments, this could well outweigh the 10% penalty and let the IRA be profitable overall despite early withdrawal.

In principle, you could imagine that you had a high tax rate in the year that you withdrew from the IRA, so it would have been better to pay the tax earlier when you had a lower rate. This is theoretically possible, but rather contrived: why would you need to draw on the last penny of your savings, in a year when you had no emergencies and significantly more income than normal?

So, scenarios where an IRA is bad are theoretically possible, but in practice more contrived and unlikely than you appreciate.

All that said, you should certainly pay more taxes if you find retirement accounts too complicated or unacceptably bourgeois.

Tom Klein,

A similar justification for income tax might be that the government provides law enforcement that promotes faith in business transactions and institutions. So those who profit from economic transactions in that environment (often making use of currency issued by the government) owe a fraction of their profit to the government for its good offices.

I understand Tom Klein to be making a PoMo, "We are all radically autonomous individuals and income taxes are controversial so they can never satisfy the doctrine of public reasons" argument; I understand Richard Mason's counter to be a "there is common-ground upon which we can all agree that income taxes are good; public safety and responsible business practices benefit us all".

At the risk of (again) being accused of saying nothing, I am going to disagree and agree with you both.

I take issue with the notion that our government "provides a free and democratic political system with an independent judiciary and national defence." First, in reply to all of your quote except the last two words, our government does not provide itself: that is nonsense. As to the last two words, I agree that national security is a public good; you, Richard Mason, and I all agree that taxes to support national security are public reasons that justify income taxation. But that doesn't mean we all agree as to how large our defense budget should be, whether we should borrow or pay in cash, whether foreign or domestic defense contractors should have the contracts, which tanks or planes or guns we should have more or less of, or what the role of the military should be, etc. Our beliefs about each of these smaller issues shapes what our ideal tax code would look like. So we can have common ground in the generalities, but disagreement over the specifics. Likewise, we might all think there's nothing wrong with the Sixteenth Amendment being in the Constitution, but then gripe about this or that provision of the tax code on becker-posner. What's more, consumption taxes are even more controversial than the income tax. People hate them. Your notion that we should have proportionate insurance for everything of value is also controversial, see Ronald Dworkin's Sovereign's Virtue. There is no way to decide what proportional is, or what value is, without taking into consideration more than ability to pay (otherwise we would assume poor people who drive without car insurance really don't want medical care); once you do that, the same can of worms is opened with determining the details of the Insurance Code. So, you get rid of the Internal Revenue Service and replace it with the Insurance Rebate Service.

To the notion that "the government provides law enforcement that promotes faith in business transactions and institutions" I say that law enforcement, like sanitation and national security, can surely be a public good, but one wonders. The police rarely investigate homicides before they occur, so they rarely actually protect you. Most murderers only commit one murder, so the police are pretty much ineffective. There is the argument that police presence may have some deterrent effect on lawlessness, but that same argument would suggest we can reduce the police force to one guy and increase sentences to 9 gazillion years to achieve the same effect. Of course, you could say, there is the limit of one's lifetime or the death penalty to be throw into play, but that is beside the point. The point is that the police only provide protection in functional relationship to the resources allocated to them, which means they work, more or less, like insurance. You allocate the resources where you think the major risks will be incurred and make sure to cover the minor risks that have major impact. (You know, you never play the lottery, except when the jackpot is ginormous.) Anyway, the point is that economic crime is "policed," say, by the SEC and the FTC, etc. But most of the economic crime could either be flushed out of the market by letting the market shake out the bad competitors, without regulation, i.e., let the cheaters and liars feel the boomerang effect of word-of-mouth, "Coke cans exploded in two of my girlfriend's faces! Pepsi never has. The next time I take a girl out I am drinking Pepsi," or is committed by corporations, which are entirely creatures of state law, which I think you were fairly suggesting. What you did not suggest is that we pass a tough federal securities law or a tough federal economic fraud law that only state attorneys general can prosecute under (more regulation could work), or suggest simply that states change their corporate law (meaning change the mandatory elements of bylaws, certificates of incorporation, reporting requirements, increase shareholder democracy, etc.) so that corporations cannot engage in certain crimes.

It seems one of you is suggesting we abolish the tax code and switch to a consumption tax, as if that is costless and the other is suggesting that there are no costs to the present regime so long as we can conceptualize justifications for it. By contrast, I agree with the posters who say that lobbying is rampant and lobbying weighs down the tax code. Good thing. Let the First Amendment reign. The tax code is the price of free speech.

W: I understand Richard Mason's counter to be a "there is common-ground upon which we can all agree that income taxes are good; public safety and responsible business practices benefit us all".

The line of Tom Klein's argument (as I understand it) is that government practices which benefit us all equally would justify a head tax.

In order to similarly justify an income tax, one would have to claim that a person with income has benefited from some government services more than a person (even a wealthy person) with less income. I don't know if that's true, though it seems plausible. It was just a suggestion.

The only thing that an IRA could possibly cost you is the 10% early withdrawal penalty.

There are also substantial costs to having one's money tied up in an IRA. The most obvious is having to take out a loan while one's money is tied up in an IRA. Other more insidious costs are the lack of flexibility that can results in devastating investment decisions (for example, not dumping a bad investment soon enough).

...the most you can have lost compared to never having the IRA is the $2,000 withdrawal fee: not $6,000 or $10,000 or any such miscalculated number.

I'm not sure if we agree or disagree here. The way I see it there are three possibilities. 1. Don't open the IRA: this is the baseline - the net financial impact is $0. 2. Open the IRA but take the early withdrawal penalty to avoid the loan: $2,000 net loss. 3. Open the IRA and take the loan: $6,000 net loss. The only way to avoid a loss is to not open the IRA.

This makes an interesting point. Supposedly the purpose of this complication to the tax code is to modify people's behavior rather than to just give rich people a tax break (they will be saving for retirement regardless). As this example shows, however, for those people who are actually trying to decide whether to save for retirement, the IRA tax policy may push then toward bad investment decisions such as taking out a loan while simultaneously having money in a savings account.

Spending every penny of your savings is itself risky and not necessarily advisable.

I agree that spending every penny is not advisable but keeping $20,000 in a savings account when that $20,000 could be used to pay off a loan sounds a bit excessive. Furthermore, given that houses cost hundreds of thousands, we could be talking about quite bit more than $20,000.

Realistically, it would probably be a better idea to keep the IRA earnings in reserve...

That depends on inflation rate. In an ecomony with high inflation, the "earnings" can rapidly dwarf the initial investment.

Imagine an economy where the inflation rate is 15% and the interest rate is just keeping pace with inflation so it is also at 15%. A $20,000 initial investment would have $327,330 of "earnings" after 20 years. That is, even if there were no real earnings, most of the IRA would be counted as earnings for tax (penalty) purposes.

You are ignoring the time value of money. Even if you have to pay tax on IRA earnings, because of early withdrawal, you may have postponed that tax for several years.

In my experience, once the real inflation rate is taken into account (not just the inflation rate that politicians fudge together to make people feel good), then it is very hard for an investment to even just keep pace with inflation. That is to say, the real time value of money is very low or even negative.

Let's assume, for the sake of argument, that the real interest rate that takes inflation into account is 1%. Someone who delays paying a 20% tax on $20,000 will have $4,000 to invest. That will yield $40/year in real interest so after 10 years someone would have $400 - not insignificant but not the lottery either.

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