Your taxes are costing you a lot more than you think. In addition to the direct burden imposed by the taxes themselves, Americans face compliance costs, as well as costs in the form of revenue loss during the IRS’ tax collection process. Pete Sepp, president of the National Taxpayers Union; Jason Fichtner, a senior research fellow at the Mercatus Center at George Mason University; and Dan Mastromarco, a partner at the Mastromarco Firm described at an event at the Heritage Foundation in November how the current tax code imposes costs on taxpayers in three key areas:
• Accounting Costs. Under the United States’ voluntary compliance tax system, it is the individual taxpayer’s responsibility to determine his income tax liability and meet filing requirements. Given the complexity of the existing tax code, many Americans either purchase tax preparation software or hire a third party to assist them during this process. According to a 2013 study by the Mercatus Center, the vast majority of Americans pay for assistance with the accounting process.
Opportunity costs must also be considered- the Taxpayer Advocate Servicer found that Americans spent 6.1 billion hours in 2010 completing IRS forms and filing returns. Even if taxpayers’ time were monetized at the low value of $10 per hour, that still leaves a cost of $61 billion per year.
Various studies have aggregated the different costs -including time spent, fees to tax preparers, and other expenses- in order to estimate the total accounting costs borne by American taxpayers each year. According to the Mercatus study (from which all data is drawn unless otherwise referenced), the costs range from $67 billion to $378 billion.
• Tax Gap (revenue loss). The U.S. tax code is extraordinarily long and complex. According to the Taxpayer Advocate Servicer report, it is nearly 4 million words long. When printed, the IRS’ guidance explaining the income tax stands more than 1 foot tall.
As if the task of navigating through countless pages of dense legal jargon wasn’t formidable enough, consider this: on average, the U.S. tax code changes every day.
The incomprehensibility of the tax code leads to predictable results: American taxpayers frequently fail to file returns on time, fail to pay reported taxes on time, or innocently underreport the amount of tax they owe. Collectively, this leads to a substantial difference between taxes owed and taxes paid on time, creating a form of revenue loss known as the tax gap. The size of the net tax gap is roughly $452 billion (in 2012 dollars).
Deadweight loss is an implicit cost of taxation that slows economic growth. Although it is more difficult to calculate, estimates of this lost economic growth range from $148 billion to $609 billion.
Even if we use the lower-end estimates from above, the combined loss from these three sources is still a staggering $667 billion. When compared against the IRS’ gross collection amount of $2.855 trillion in 2013, this number indicates that, out of every $100 collected, over $23 was lost. When we bring in the higher-end estimates, the loss soars to an enormous $1.439 trillion. This equates to roughly $50 being lost for every $100 collected.
The magnitude of these numbers begs an even larger question: why don’t people seem to care? In part this is due to the narrow and disproportionate incidence of the tax burden. 43 percent of individuals pay no income tax. Of those who do pay income taxes, only one-third experience the costs by itemizing rather than by taking the standard deduction. Moreover, when employers withhold taxes from pay the accounting costs are felt by a much smaller pool of people.
Additionally, the burdens these costs impose are often passed on and concealed under the guise of lower wages and decreased portfolio returns, or are unseen altogether in the form of businesses that are never established.
So how do we reduce the compliance costs of America’s convoluted tax code? The answer is simple: move to a simpler, more transparent system based on a consumption tax. A consumption-based tax code would dramatically reduce complexity and therefore lower accounting costs as well as the tax gap. It would also reduce deadweight loss. Income taxes (especially the corporate income tax) discourage saving and investing, activities that are critical for economic growth. By not penalizing the production side of the economy, consumption taxes minimize this burden. According to Curtis Dubay: “Trying to tackle each of these issues individually ignores the cause of the problem: the broken and outdated tax system. The right way to fix these problems, and the countless others with the tax code, is through fundamental tax reform that applies a low rate to a consumption base (one that doesn’t tax saving and investment multiple times).”
