Today marks my 15th year at the Tax Foundation. Looking back, the world was different when I started: people still had dialup internet, Bill Clinton was president, and the Tax Foundation was just seven people in a small...
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A Stark Reminder of the Excessive Cost of Complying with the Tax Code
Last week, Nina Olson as the National Taxpayer Advocate (NTA) cited tax complexity as the most prominent issue facing taxpayers in her annual report to Congress. To most of us, this is no surprise. We either gruelingly spend hours scratching our heads as we try to fill out our tax returns or, like a majority of taxpayers, pay someone else to handle our tax returns.
Nina Olson presented the facts and figures that capture our agony. Congress has consistently added to and altered our tax code 4,680 times since 2001, averaging more than one change per day. The tax code now totals almost 4 million words, which is about five times the length of the Bible and five times the length of the Federal Tax Code in the 1950s. Americans spend 6.1 billion hours every year attempting to comply with the internal revenue code, at a monetary cost of about $168 billion. Due to the complexity of the tax system, 59% of individual tax payers hire tax preparers to complete their returns while another 30% of individual tax payers pay for software to facilitate their tax returns. The average taxpayer spends about $258 dollars in out of pocket expense to comply plus about 18 hours of time.
All in all, the growing complexity of the tax code, riddled with income exclusions, deductions, and credits, raises the opportunity cost of tax compliance. Time spent completing tax returns or the cost of hiring a tax preparer shifts resources away from more productive avenues. Further, the constantly changing tax code heightens uncertainty among taxpayers. Instead of fostering an efficient and productive economy, the tax code leaves taxpayers with headaches and frustration.
This frustration fuels what Nina Olson describes as the growing lack of trust in our federal tax code. She finds that only 16 percent of taxpayers believe the tax laws are fair. This perception boosts tax avoidance and tax evasion. Paying your taxes is no longer a patriotic duty. Instead, minimizing one’s tax burden becomes more rewarding. As Keynes said, “the avoidance of taxes is the only pursuit that carries any reward.” Plato once asserted that “where there is an income tax, the just man will pay more and the unjust less on the same income,” but now, it is the smartest man who pays less on the same amount of income. The contagion of this mindset of “working the system” spreads to all incomes whether one is attempting to maximize after tax income through the Earned Income Tax Credit or the Alternative Minimum Tax. However, the complexity of the tax system is more fruitful for higher income earners due to the regressivety of deductions and high income earner’s ability to afford superior tax professionals, which raises equity questions about the structure of the tax code
In addition to compliance costs, administration costs for the IRS, and the undermining of the integrity of our tax system, Nina Olson highlights the fact that significant tax revenue is lost through complexity. Current tax expenditures cost the government $1.09 trillion dollars in lost revenue. For all these reasons, the Taxpayer Advocate Service recommends that Congress apply zero-based budgeting to reform the tax code, meaning start with zero tax expenditures and then judge the value of each tax expenditure based on the following criteria: “encouraging the activity for which the tax incentive is provided, whether the incentive is accomplishing the intended purpose, and whether the tax expenditure is more effective than a direct expenditure for achieving that purpose.”
In sum, Nina Olson once again reminds us of the failings of our tax code in terms of complexity and compliance. Her suggestions for improvement are sound. By these standards, the recent fiscal cliff deal, and virtually every tax deal of the last decade or more, has only made the problem worse.
See also: Tax Foundation Complexity Costs
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