The Rising Cost of Complying with the Federal Income Tax

January 10, 2006

Special Report No. 138

Executive SummaryIn 2005, taxpayers will pay roughly $1.2 trillion in federal income taxes. But America’s tax burden is more than just the amount of tax paid. It also includes the cost of complying with federal taxes, including tax planning, paperwork and other hassles caused by tax complexity.

In the last century the cost of tax compliance has grown tremendously. This is due partly to the inherent difficulty of taxing income, but also because of growing non-economic demands lawmakers place on the tax code. As Congress debates the tax reform recommendations of the President’s Advisory Panel on Federal Tax Reform, Members should address this growing compliance burden, and work to reduce it through tax simplification and reform.

In 2005 individuals, businesses and nonprofits will spend an estimated 6 billion hours complying with the federal income tax code, with an estimated compliance cost of over $265.1 billion. This amounts to imposing a 22-cent tax compliance surcharge for every dollar the income tax system collects. Projections show that by 2015 the compliance cost will grow to $482.7 billion.

The burden of tax compliance does not fall evenly on taxpayers. It varies by type of taxpayer, income level and state. In 2005, businesses will bear the majority of tax compliance costs, totaling nearly $148 billion or 56 percent of total compliance costs. Compliance costs for individuals will be $111 billion or 42 percent, and non-profits will bear nearly $7 billion or 2.5 percent of the total.

When examined by income level, compliance cost is found to be highly regressive, taking a larger toll on low-income taxpayers as a percentage of income than high-income taxpayers. On the low end, taxpayers with adjusted gross income (AGI) under $20,000 incur a compliance cost equal to 5.9 percent of income while the compliance cost incurred by taxpayers with AGI over $200,000 amounts to just 0.5 percent of income.

State-by-state estimates of the 2005 federal compliance cost also vary widely because state populations and economies differ so significantly. On a per capita basis, Wyoming ($1,242), Delaware ($1,181) and Colorado ($1,167) face the highest compliance cost while Mississippi ($658), West Virginia ($689), and Tennessee ($705) face the lowest. Measured per $1,000 of income, Montana ($38), Utah ($37), and Wyoming ($33) face the highest compliance cost while California ($19), Connecticut ($20) and Massachusetts ($21) face the lowest.

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