Economist Gary Becker on Tax Compliance Costs

April 18, 2006

Nobel Laureate economist Gary Becker provides an excellent overview of the economics of tax complexity, including our own study of federal income tax compliance costs:

As my wife and I were recently preparing our income tax data to give to our accountant, I began my annual guess about the cost of complying in the U.S. with the Federal Tax code. But instead of just shaking my head over it, as I usually do, I made a few simple calculations that I will share with our readers. I will also offer some suggestions on how to cut down drastically compliance costs and reduce the negative effect of federal taxes on the efficiency of the economy.

We spent at least 25 hours in 2005 preparing and keeping track of our 2005 income, deductible expenses, and other data relevant for tax purposes. Our accountant spent another 6 or so hours, so together our tax filing used over 30 hours. Last year the IRS processed about 130 million tax returns. If the average filer along with any professional help together spent about 20 hours, 2.6 billion hours would have gone into complying with the 2005 tax code. This may seem huge, but the Tax Foundation put much more effort into their calculations, and finds that about 6 billion hours were spent in complying with the federal income tax code alone…

If we value my 2.6 billion hours estimate conservatively at an average of about $40 per hour because higher income filers and tax preparers spend many more hours in tax preparation than lower income filers, the aggregate cost of complying would be over $100 billion. This is almost 10 per cent of the approximately $1.2 trillion that will be paid in 2005 in federal income taxes. The Tax Foundation concludes that total compliance costs for 2005 will amount to $265 billion, or over 20 per cent of federal income tax revenue. (Full piece here.)

Here are a couple illustrative figures on the costs of complying with the federal income tax, from our study released in January.

The first illustrates the tax compliance “surcharge” borne by the economy in addition to actual tax collections. This year that surcharge is estimated to be 22 cents per tax dollar collected. As the time series shows, there’s been a dramatic increase in this compliance burden since 2000.

This has likely occurred for two reasons. First, while tax collections fell steeply during the most recent recession, compliance costs did not, suggesting they’re less cyclical than collections. Second, although federal income taxes were substantially cut in recent years, it’s unlikely they made the tax system simpler, since they were often accompanied by expansions of complex tax preferences rewarding family structure, alternative energy production and various other social goals.

Federal Income Tax Compliance Costs as a Percentage of Revenue Collected, 1990-2015:

The second illustrates an often-ignored aspect of tax compliance costs—they’re highly regressive. This shouldn’t be a surprise to anyone who’s explored the staggering complexity of tax provisions targeted at low-income Americans such as the Earned Income Tax Credit. For this reason, tax simplification is one type of tax reform lawmakers on on all points of the political spectrum should be willing to support:

The Regressive Distribution of Federal Individual Income Tax Compliance Costs:

Read the full study here.

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