The Burden of the U.S. Tax Code

“[The U.S. income tax is] a disgrace to the human race.” — President Jimmy Carter

[Editor’s note: I would probably get more mileage out of this post if I published it during “tax season”. On the other hand, it is a perennial topic, so maybe it will pique someone’s interest….]

frustrated taxpayerWe all like to complain about preparing and paying taxes, especially income taxes. And rightfully so. I’m not going to get into the issues of whether or not income tax is constitutional, whether or not the IRS should be abolished, etc. Just for now, let’s assume that some such tax is necessary, legal, and needs to be administered. As I have recently been reading through Hall & Rabushka’s The Flat Tax, 2nd ed. (1995), I have been reminded of just how astoundingly huge are the total costs in time, effort, and money that go into the functioning of and compliance with our current tax system — totally aside from the taxes themselves. Also, the unbelievable complexity of the tax code and inefficiencies of it all are just ridiculous!

“The federal income tax is a complete mess. It’s not efficient. It’s not fair. It’s not simple. It’s not comprehensible. It fosters tax avoidance and cheating. It costs billions of dollars to administer. It costs taxpayers billions of dollars in time spent filling out tax forms and other forms of compliance. It costs the economy billions of dollars in lost output of goods and services from investments being made for tax rather than for economic purposes. It involves tens of thousands of lawyers and lobbyists getting tax benefits for their clients instead of performing productive work. It can’t find ten serious economists to defend it. It is not worth saving.”

The authors give several examples of direct and indirect costs of compliance and administration. I’ll just give one here, which happens to be somewhat relevant to current events in the news:

“Every year, the IRS undertakes more than one million audits, which are heavily focused on high-income taxpayers and large corporations. The cost to taxpayers of office, field, and mail audits easily exceeds $1 billion, with assessed penalties another $2 billion. The IRS’s own annual reports admit a high rate of errors, and the IRS telephone information service gives out wrong answers as much as one-third of the time. A General Accounting Office study of the IRS’s business nonfile program found an error rate of 75 percent. Keep in mind that the government does not bear the cost of its errors; they are shifted onto taxpayers who must defend themselves against IRS mistakes. Payne documents more than a dozen government investigations of IRS mistakes. The important numerical finding is that the private-sector burden of initial enforcement contacts is higher than the total budget of the IRS. Here the taxpayer pays twice: once, to pay IRS salaries and overhead, second, to defend himself from the IRS. Estimates of tax litigation stemming from IRS contacts are again in the multibillion dollar range.”

And that was 20 years ago! I don’t know about error rates, but I’m sure that the estimated costs have grown along with everything else. Also, while typing this, I can’t help but think of the parties and bonuses enjoyed by IRS personnel, which we have been hearing about lately.

“To be fair, the IRS is responsible for ensuring compliance with the tax code. Those who make mistakes or deliberately misreport income and deductions should be required to meet their lawful tax obligations. Therefore, a portion of these compliance costs is a legitimate burden of taxpayers. The difficulty arises from the complexity of the tax code. It’s easy to make mistakes, even when taxpayers purchase electronic tax preparation programs. In addition, frustrated taxpayers are not likely to take extreme care with each of the hundreds of entries in as many as a dozen or more forms…. A simple system of low tax rates would remedy a good part of this.

… On balance, we think it fair to estimate compliance costs imposed on individuals and businesses at a minimum of $100 billion but probably higher.”

Cover to The Flat Tax, 2nd editionFun fact: According to the most recent (2012) IRS estimate I could find for tax revenue lost due to evasion (i.e., where taxes are illegally underreported and underpaid), the “net tax gap” for 2006 is estimated to be $385 billion.

There is, of course, much more to say on this. In short, I think we can all agree that it is foolish to continue limping along with such a burdensome tax code & system. We need something simpler, fairer, more time- and cost-efficient. From what I have read so far, I really like Hall & Rabushka’s proposal, which has had bipartisan support and been brought up for congressional consideration multiple times over the years. What about you?

P.S.  I highly recommend the book, too. Note that the “Hoover Classics” edition published in 2007 (and linked to above) is the same “second edition” I’m reading, with the cover seen here. (The original came out in 1985.) I *hope* they put out an updated (with recent numbers and other historical facts), 30th-anniversary edition in 2015.

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