The Tax Policy Blog

Excess regulatory costs are like sand in the gears of commerce, diverting companies' attention toward legal and administrative tangles and away from productive work. 

The Small Business Administration's Office of Advocacy has released a new study (PDF) on the costs of federal regulations on small businesses, including the costs of complying with the federal income tax. In fact, the paper's section on tax compliance relies on the Tax Foundation's own 2002 study of compliance costs by economist J. Scott Moody:

The estimate of the cost of federal tax compliance relies on a 2002 report by the Tax Foundation that provides extensive details about the time required to file federal income tax returns...

The basic approach to the computation of tax compliance costs is straightforward and easy to describe. The first step uses data from the Internal Revenue Service on the amount of time required to complete each type of tax form, and the number of filings for each type of form...

The number of compliance hours is broken down in Table 6 for businesses, nonprofits, and individual filers. The total number of hours required for compliance is nearly 5.8 billion per year, and American businesses account for roughly half of the total hours.

Read the full SBA study here. The press release is here. For more on the cost of tax compliance see here.

According to yesterday’s Atlanta Business Chronicle, this month’s temporary repeal of Georgia’s state gasoline tax is soon set to expire.

“Beginning Oct. 1, distributors will collect about 15 cents more for each gallon of gas they deliver into a retailer's pumping tanks. Gov. Sonny Perdue temporarily suspended the collection of the state's motor fuel taxes on Sept. 2 "to relieve some of the financial burden placed on Georgians by the disruptions of our fuel supply resulting from the effects of Hurricane Katrina." His action was ratified by the Georgia General Assembly on Sept. 10. [Full Story]

Recent Tax Foundation research noted that, “today, the combined burden of federal, state and local gas taxes costs American drivers an average of 45.9 cents on every gallon purchased. According to data on gasoline use from the U.S. Department of Transportation, that amounts to an annual gas tax burden of roughly $271 for every man, woman and child in the United States.” While the short term change in price is determined by the forces of supply and demand, Americans need to remember the significant burden that gas taxes place on the long term cost of gasoline. 

You can read the Tax Foundation’s new Fiscal Fact on gas taxes here.

As U.S. lawmakers work toward a permanent repeal of the federal estate tax—the so-called “death tax”—our friends in Russia are moving in the opposite direction, proposing an actual death tax on funeral services. From today’s Moscow News:

The regional legislature in southern Siberia’s Kurgan has approved amendments to the imputed tax law that will introduce taxation for religious rituals such as funerals and baptisms, the Vedomosti business daily reported on Tuesday. The move has already caused protests from the Orthodox Church and the Finance Ministry. [Full Story]

This bizarre story should remind Americans that our own version of the death tax will return unless action is taken. While the most recent tax cuts eliminated the federal estate tax, thanks to the sunset provision it’s scheduled to return in 2011.

For more on estate and gift taxes, see here.

In the next few weeks, many tax commentators will argue that the physical presence rule (generally embodied in H.R. 1956, which will be heard today in the House Subcommittee on Commercial and Administrative Law) would violate the principles of federalism, would short-circuit a state-led solution to corporate tax complexity, would violate state sovereignty, and would increase tax sheltering. The following thoughts are important to remember when evaluating these claims:

1. One of the driving issues behind the calling of the Constitutional Convention in 1787 (and the Annapolis Convention in 1786) was the lack of a power in Congress to regulate commerce among the states. The impotence of Congress in this area was severely impacting commercial relations with foreign nations and between the states themselves.

2. James Madison’s Notes of Debates in the Federal Convention of 1787 reveals that many founders—including two of the most famous—had a great deal of frustration over the usurpation of rights and liberties by the States. James Madison was so frustrated with the States at the time of the founding that he even wanted to give the federal government an absolute veto power over all state legislation. Alexander Hamilton wanted to abolish the States altogether. The small states at the time obviously would have none of that, but the Constitution ultimately did give Congress an absolute veto over state regulation of interstate commerce.

3. Giving the power to regulate commerce to Congress is a judgment that an integrated national market is more important than the taxing authority of the States. Thus, statements such as "Congress should exercise its authority only to further cooperative efforts among the states to simplify ...their tax systems" miss the mark entirely. Congress is free to set aside those state tax laws that, in its judgment, negatively impact interstate commerce and thereby hinder national economic growth.

4. H.R. 1956 would not exacerbate corporate tax sheltering. The states have a number of ways to fight corporate tax shelters. Lee Sheppard says that combined reporting is the best tool, arguing that “…[e]very single tax shelter trend identified by the MTC in its tax shelter report is directly traceable to the failure to require combined filing.” A federal physical presence requirement will not keep the states from fighting tax shelters.

Just yesterday, we released a report showing how the physical presence standard for business activity taxes is consistent with the benefit principle of taxation as well as international tax practice. Click here to read the report.

Today, bay watchers in San Francisco may find more than the tide rolling away. According to several stories in the San Francisco Chronicle this weekend, 30,000 quarterly tax payments were lost in San Francisco Bay.

“Thousands of tax payments and other correspondence sent to the Internal Revenue Service were dumped into San Francisco Bay following an automobile accident. An additional 15,000 tax payments were recovered after the accident, which occurred on the San Mateo Bridge as the courier traveled from the San Francisco post office to a check-processing facility in Hayward, the IRS said. [Full Story]

The lost payments are estimated to represent only 2 percent of September’s volume at the IRS facility in Hayward, California. This story highlights the massive amount of paperwork that the current tax system requires of everyday Americans.  Americans are now coming to realize that the current tax system is far too complicated. According to a recent poll commissioned by the Tax Foundation and conducted by Harris Interactive®, “an overwhelming 81 percent of adults believe the federal income tax is somewhat or very complex, and 70 percent said they either “hated” or “disliked” doing their income taxes.” A recent study by Tax Analysts points out that Americans currently spend an average of 21 hours in order to comply with the complexities of the status quo each year.   Let’s hope the President’s Advisory Panel on Federal Tax Reform presents a straightforward plan to eliminate the reprehensible complexity of the tax code.

Despite the political popularity of the tax deduction for home mortgage interest, economists are basically united in their opposition to it.

What's the economic case against it? Simple: by giving a tax subsidy to housing, it distorts investment decisions toward houses and away from assets like factories and equipment that are more productive at the margin. And that makes workers less productive, ultimately lowering wages and making society poorer.

A recent GAO primer on tax reform makes a clear and persuasive case against the mortgage interest deduction:

Tax Treatment of Owner-Occupied Housing Distorts Investment Choices and Lowers Wages
Compared to other types of investment, owner-occupied housing enjoys tax advantages primarily because the value that homeowners receive from housing services, which is a part of the return on their investment in housing, is excluded from taxation. Economists view these services, called imputed rent, as income in kind, which is valued at what the homeowner would receive as income if the house was rented.

Under a pure income tax, imputed rent net of such costs as mortgage interest would be taxed. This tax treatment would help insure that investment in housing is taxed as other investments are taxed. As the table below shows, the tax advantages under the current system lead to lower marginal effective tax rates (METR) for housing relative to other investments.

Marginal Effective Tax Rates on Capital, by Source, 2003

Owner-occupied housing: 2%

Noncorporate investment: 18%

Corporate investment: 32%

Source: Jane Gravelle, “The Corporate Tax: Where Has It Been and Where Is It Going?” National Tax Journal, vol. 57, no. 4 (2004): 903-23

Economists generally agree that the favorable treatment of owner-occupied housing, by lowering METR, distorts investment in the economy, resulting in too much investment in housing and too little business investment. The consequence of this is that businesses invest less in productivity-enhancing technology. This in turn results in employees receiving lower wages because increases in employee wages are generally tied to increases in productivity.

The resulting distortions from the tax-preferred treatment of owner-occupied housing lead to efficiency costs that have been estimated to be large. Gravelle’s summary of estimates reports that the efficiency costs of the tax-preferred treatment of owner-occupied housing could be as much as 0.1 to 1 percent of GDP.

That's from a text box on page 39. Let's hope Members of Congress—who may be taking on federal tax reform next year—are actually reading these excellent GAO reports. Read the full report here (PDF).