THE COSTS OF TAX COMPLEXITY Presentation to the President

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THE COSTS OF TAX COMPLEXITYPresentation to the
Presidents Advisory Panel on Federal Tax Reform

• Joel Slemrod
• March 3, 2005

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• The Resource Cost of Collecting Taxes
• The IRS budget administrative costs.
• The time and money spent by taxpayers and third
  parties compliance costs.
• The latter dwarfs the former, which is about 10
  billion annually.

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How Big Are Compliance Costs?

• Individuals 85 billion. This includes the
  value
• of 3.5 billion hours of time, the
  equivalent of
• nearly two million hidden IRS employeeswe
• the taxpayers.
• Businesses (other than sole proprietorships)
• 40 billion.
• Total 125 billion. This comes to nearly 13
• cents per dollar of income tax receipts,
  and is
• more than 12 times higher than the IRS
• budget. The cost ratio has probably, but
  not
• certainly, grown in the last two decades.

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The Nature of Compliance Costs

• Almost two-thirds of the cost is due to
• recordkeeping.
• Costs are highly concentrated. Forty million
• taxpayers spend five hours or less per
  year.
• Compliance costs rise with taxpayers income and
  tax
• liability, but less than proportionately
  compliance costs
• are regressive.
• Costs are particularly high for self-employed
• taxpayers.
• Tax software reduces the difficulty of filling
  out
• forms and doing calculations, but does not
  
• reduce the burden of recordkeeping.

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Other Costs of Tax Complexity

• Complexity causes a capricious and often
  uncertain distribution of tax burdens. Even
  professionals often disagree about the tax
  liability.
• It rewards those who have the means and
  inclination to find all the angles.
• It undermines trust in the fairness of the tax
  system, which may in turn undermine voluntary
  compliance.
• It reduces the transparency of the tax system.

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Why Is It So Complex?

• It reflects a belief that simpler, or less
  conscientiously enforced, systems cause an unfair
  distribution of the tax burden.
• The tax system is an awkward mixture of a
  revenue-raising system plus scores of incentive
  and reward programs.
• Income (and especially capital and corporate
  income) is often inherently difficult to measure,
  leading to inconsistencies that reward
  complicated transactions such as tax shelters and
  tax-oriented financial products.

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Evidence from Other Countries

• Only 6 countries in history have operated RSTs at
  rates of 10 percent or more none do now.
• The cost-revenue ratio of European VATs ranges
  from 3 to 5 percent.
• The cost-revenue ratio for European income taxes
  is apparently not much higher than for their
  VATs, and is much lower than for the U.S. income
  tax reliable comparable statistics are, however,
  scarce.

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What Are the Keys to Simplifying the Tax System?

• Resist fine-tuning the tax liability of
  individuals.
• Resist fine-tuning the economy by subsidizing and
  rewarding activities deemed to be especially
  valuable.
• Simplify sufficiently to take advantage of
  large-scale withholding by business, either
  radically as in a VAT or through a return-free
  income tax system.

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What Are the Tradeoffs to Be Faced in
Simplifying the Tax System?

• Simpler business-based taxes like the VAT involve
  a massive redistribution of tax burden away from
  high-income to low-income families.
• Simplifying the tax base restricts activist
  government and requires settling for rough
  justice.
• Nothing simplifies the tax system without also
  affecting equity and efficiency.
• Transition to an even simpler new system will
  entail one-time costs as new rules are
  assimilated.

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Appendix Are There Simpler Alternatives?

• The retail sales tax seems simpler, but at the
  revenue-neutral tax rate would not be
  administrable at our usual standard of equity and
  intrusiveness.
• A value added tax is administratively more
  robust, and could cut compliance costs
  significantly if it replaced the income tax.
• A true flat tax could cut compliance costs in
  half, but facilitates the reintroduction of
  complicating incentive and reward programs.

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Appendix Table 1 Details of Recent Estimates of
the Collection Cost of the U.S. Income Tax System
Slemrod (1996)1 TY1995 IBM (2003)2 TY2000 Slemrod (2004)3 TY2004
Individuals
Hours (bil.) 2.8 3.21 3.5
Average value per hour () 15.0 20.0 20.0
Value of hours ( bil.) 42.0 64.2 70.0
Expenditures ( bil.) 8.0 18.8 15.0
Total resource cost ( bil.) 50.0 83.0 85.0

All businesses, other than sole proprietorships
Hours (bil.) 0.8
Average value per hour () 25.0
Total resource cost ( bil.) 20.0 40.0
(continued on next slide)
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Appendix Table 1 (continued)Details of Recent
Estimates of the Collection Cost of the U.S.
Income Tax System
Slemrod (1996)1 TY1995 IBM (2003)2 TY2000 Slemrod(2004)3 TY2004
Total compliance cost ( bil.) 70.0 125.0
Total administrative cost ( bil.) 5.0 10.0

Total collection cost ( bil.) 75.0 135.0

Ind. income tax receipts ( bil.) 590.2 1004.5 809.0
Corp. income tax receipts ( bil.) 157.0 207.3 189.4
Total income tax receipts ( bil.) 747.2 1211.8 998.4

Total collection cost as a of total income tax receipts 10.0 13.5
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Appendix Table 1 (continued)Details of Recent
Estimates of the Collection Cost of the U.S.
Income Tax System

• Notes to table All dollar figures are in
  current dollars. The tax receipts figures refer
  to fiscal years, and are taken from Economic
  Indicators, December 2004 (U.S. Government
  Printing Office, Washington, D.C.).
• 1 Slemrod (1996) refers to detailed estimates
  discussed in my article entitled Which Is the
  Simplest Tax System of Then All? published in H.
  Aaron and W. Gale (eds.), The Economics of
  Fundamental Tax Reform, The Brookings
  Institution, 1996, pp. 355-91.
• 2 IBM (2003) refers to the IBM Business
  Consulting Services contract work with the IRS,
  discussed in Guyton, John L., John F. OHare,
  Michael P. Stavrianos, and Eric Toder,
  Estimating the Compliance Cost of the U.S.
  Individual Income Tax, National Tax Journal
  (September, 2003), pp. 673-88.
• 3 Slemrod (2004) refers to written testimony
  submitted to the Committee on Ways and Means,
  Subcommittee on Oversight, Hearing on Tax
  Simplification, Washington, D.C., June 15, 2004.
  Only the tax receipts numbers have been updated
  from that testimony.