27 July 2006

Is Tax Compliance Is A Serious Problem?

Tax professor and blogger James Edward Maule thinks that the compliance burden of the tax code is a big deal. This, in turn, leads him to conclude that:

Is it me or does it seem obvious that taxpayer burden will not be alleviated until the tax law is simplified and fixed? Does Congress need a hearing to make this determination? What’s next, hearings on whether the earth is flat? Yes, I know about the Flat Earth Society and I know there are people who think the tax law is child’s play.

The numbers are big. But, viewed in context, I don't think that the number's that he's citing are the important ones.

For example, he notes that "in 2006, taxpayers will spend more than 6 and a half billion, yes, billion hours complying with the tax law." My question is, so what?

There are about 300 million people in the United States, before you even begin to consider about 30 million small businesses, several hundred thousand large C corporations, several million trusts and estates, and a not insubstantial number of non-resident taxpayers. Thus, the average American spends about 20 hours a year complying with federal tax laws, which works out to about three days a year, with generous lunch breaks. Better organized people can spend about an hour a month, plus one day of tax preparation work when your return is due. It isn't a perfect, but compliance costs are a quite small portion of the total economic burden of taxation in general on the average person.

For the 80% of people who are neither business owners, nor high income people with substantial investment income, compliance costs are usually trivial in proportion to either their total tax burdens including compliance costs, or their incomes. For the small number of big businesses that make up a huge proportion of all economic activity in the United States, compliance costs are high, but they have to be weighed against the immense overall tax burdens involved. Hiring a big tax accounting firm to do your tax work isn't so overwhelming when your bottom line is in the vicinity of ten billion dollars a quarter.

There is a tax compliance cost problem in the United States, but it isn't that average tax compliance burdens are high. The problem is that select subgroups, like low to moderate revenue small businesses, incur high compliance cost relative to their incomes (and often still muck it up, in part due to willful, self-serving neglect), even though others, like wage and salary earners and big businesses, incur quite moderate compliance costs relative to their revenues.

If you are a sole proprietor whose has $100,000 of revenues, mostly in small transactions, and $70,000 of expenses encompassing a full range of business expenses, including employees, you have tax compliance costs quite similar to a business ten or a hundred times as large, and far higher than someone who simply make a $30,000 salary. Of course, on the other hand, the odds are good that you will fail to report about $15,000 of your correct net income.

I'm also not terribly surprised that "three-fourths of the compliance burden imposed by the federal government is on account of taxation." Many federal programs, like national defense, making interest payments on the national debt, Medicaid, Medicare, Social Security, TANF, Food Stamps, and the national highway and commercial air travel systems cost quite a bit of money, but impose very few regulatory burdens on the average person. The compliance burden associated with taxation is to a great extent an irreducible burden associated with having a functioning government. The fact that other federal programs impose a very low compliance burden on most people is both proof that federalism works (a large share of compliance costs are state and local) and proof that the federal government is overall run in a quite citizen friendly manner.

Tax complexity, of course, can be a problem. But, I worry much more about the capacity of the tax code to distort economic decision making in negative ways on a widespread basis, than I am about the cost of filling out tax forms and collecting records to do so. For example, the potential downsides of our existing tax system's bias in favor of debt over equity funding for publicly held corporations makes our economy more prone to major business failures during economic downturns. It takes only a small number of unnecessary Chapter 11 bankruptcies to make tax compliance costs look like small potatoes.


Anonymous said...

I've got some issues with the tax code. Check out my post at http://againstthecurrent-omaha.blogspot.com/2006/07/curtailing-tax-code-in-senate-bill.html

Andrew Oh-Willeke said...

Interesting, I saw your proposal to stagger filing deadlines based on social security number.

For wage and salary earners it makes sense. But, the trouble is that people who are self-employed or have investments need K-1s from S corps, partnerships and trusts, and 1099s that need to dovetail with the filing deadlines. And, many businesses are on fiscal years that put related expenses and gains in the same year smoothing income.