Fact Checking the Fact Checkers: Missing the Point on Tax Compliance

December 14, 2011

Speaker John Boehner and Texas Governor Rick Perry recently claimed that federal income tax compliance costs about $500 billion per year, apparently basing it on a 2005 report of ours in which we project that compliance costs will be $483 billion in 2015. Politifact rightly points out that our projection to 2011 is there as well, and that's $392 billion.

Politifact could have also argued that a 6 year projection is getting a little questionable.  The reason we haven't updated this report is because we based it on IRS estimates of the time to fill out each tax form, a methodology the IRS discontinued in 2006.  So we projected based on a fairly well established trend up to that point.

Instead, Politifact takes issue with the fact that we assigned a dollar amount to these IRS estimates of time, based on average wages:

"Boehner, as did Perry, made a valid point - that a whole lot of money is spent on tax preparation in the United States today. But their numbers are not close to accurate, and a huge part of the dollar cost they mention is not money that anyone actually spends. Rather, it is the value placed on the time people take for preparation.

On the Truth-O-Meter, we rate the claim Mostly False."

Politifact apparently doesn't understand one of the most fundamental concepts in economics: that of opportunity costs.  Conveniently, we explain it in the same 2005 report, under the section titled Opportunity Costs:

"Every hour or dollar spent complying with the tax code represents resources that could have been spent tending to business problems, adding value to the U.S. economy."

Time, money... they are all costs.  We simply used a very standard technique of expressing time in terms of money.  It's an imperfect estimate for sure, but it's the best we can do.

Or could do at the time.  The IRS continues to provide compliance costs estimates in terms of time, just no longer on a form-by-form basis.  Their latest estimate is that in 2011 complying with the federal income tax system will cost businesses and individuals over 7 billion hours.  This is a significant increase since 2005, when the total time was 6 billion hours.  And as the IRS notes, the increase would be even greater were it not for the fact that now 90 percent of individual taxpayers pay for professional tax preparation or tax software.

A rough estimate in terms of dollars, based on the average income of filers in 2009 (most recent), is $191 billion in compliance costs.  This is an underestimate for two reasons: 1) it only accounts for cash wages, but fringe benefits, especially healthcare, are a large and increasing share of total compensation, and 2) it is very likely the case that the more a person makes the more time he spends on his return.  These factors could easily double the current estimate of compliance costs to upwards of $400 billion - close to our projection back in 2005.

Follow William McBride on Twitter @EconoWill

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