The Case for Trump’s Tax Plan Is Strengthened By IRS’s $300 Billion Compliance And Deadweight Burden
Donald Trump made his most urgent appeal for middle class tax cuts in North Dakota, the home state of Sen. Heidi Heitkamp, a Democrat who has called for the parties to work together.
Heitkamp happens to be someone concerned about the profusion and complexity of regulatory guidance in general, and IRS tax complexity is a primary offender, something described in this column last week. Heitkamp also is the leading Democrat on commonsense bipartisan regulatory reform more generally, in the form of the Regulatory Accountability Act.
Trump’s speech emphasized the time and money individuals are forced to waste in complying with the complex tax code. It’s a different emphasis from the typical focus on the corporate income tax, which needs to come down, too.
The cost of tax compliance is not accounted for anymore these days in the economic and social regulatory categories once reviewed and assembled by the White House Office of Managment and Budget.
The attention once paid to tax compliance costs should be renewed. Today, such costs make the case for reform much more apparent. Way back (at the turn of the century) in Total Annual Costs of Regulations as of Sept 30, 2001 According to OMB, tax compliance was captured in the “Process/Paperwork” row formerly presented by OMB in addition to economic and social costs (in annual reports to Congress, OMB still compiles a small amount of the latter two).
The audiences Trump is trying to reach might note that OMB pegged paperwork at up to $190 billion in 2001, or around $250 billion in today’s dollars, or nearly 20 percent of the total $1.255 trillion in annual regulatory costs in that chart.
Trump’s tax reform push makes it a good time to bring tax compliance figures up to date a little. With respect to estimating costs of compliance with the federal tax code, one 2010 report for the Small Business Administration divided costs between businesses and individuals/nonprofits, using also Bureau of Labor Statistics (BLS) figures of $49.77 and $31.53 per hour, respectively. Relying primarily on 2008 Internal Revenue Service data regarding paperwork hours for businesses and individuals/non-profits., this study tabulated an overall burden of 4.3 billion hours (2.3 billion for businesses and two billion for individuals and non-profits). Using the BLS data on hourly wage rate for tax form preparation, this report computed $159.6 billion for compliance in 2009 dollars.
However this report (see Crain and Crain, Table 4, Sources and Estimated Costs of Compliance with the Federal Tax Code. p. 29.) was conservative in this respect compared to other governmental estimates.
In a 2005 report, the Government Accountability Office had noted low-end estimates of tax compliance costs at $107 billion, or one percent of GDP at the time. Taking into account efficiency costs in the economy, GAO further cited reports assessing mid-1990s tax compliance costs at two to five percent of GDP annually. Even these still were not “comprehensive estimates of the efficiency costs of the current federal tax system.”
Earlier this year when I initially compiled these numbers, the Commerce Department’s Bureau of Economic Analysis current-dollar estimate 2015 GDP was $18.45 trillion. All else equal, two to five percent of that would mean a range of $369 billion to $922 billion today. That boggles the mind.
More recently in a 2011 “Tax Gap” testimony to the U.S. Senate Committee on Finance, GAO referenced the 2005 study:
“GAO reviewed existing studies and reported that even using the lowest available compliance cost estimates for the personal and corporate income tax, combined compliance costs would total $107 billion (roughly 1 percent of gross domestic product) per year; other studies estimate costs 1.5 times as large. Economic efficiency costs, which are reductions in economic well-being caused by changes in behavior due to taxes, are estimated to be even larger.”
So, in today’s numbers, GAO would seem to have us baselining at $184 billion in direct compliance [one percent of today’s $18.45 trillion GDP], and at least (probably more) that same amount again in indirect or efficiency costs, for a minimum of $369 billion (but likely considerably more).
This $369 billion figure may be put in context with other reports estimating tax compliance burdens. A 2013 Mercatus Center study, “The Hidden Costs of Tax Compliance,” finds “hidden costs [here counting both accounting costs and economic costs] of tax compliance range from $215 billion to $987 billion annually.”
And a 2011 Laffer Center report finds “that U.S. taxpayers pay $431.1 billion annually, or 30 percent of total income taxes collected, just to comply with and administer the U.S. income tax system.” Only about $12 billion of that was IRS budgetary costs. These seem in line with earlier framing.
In a 2005 report, at a time when 2004 costs were $244 billion, the Tax Foundation projected 2010 overall tax compliance costs would amount to $338 billion, and projected costs in 2015 of $406 billion (in 2005 dollars). Still earlier studies by the University of Michigan Business School found business tax compliance costs at $102.3 billion in 1993, and $141.1 billion in 1995. As for direct compliance alone, the National Taxpayers Union in 2014 found federal tax compliance to cost $226 billion, with the labor required for tax compliance to amount to $192.6 billion and tax software at $31.7 billion.
Those are all big numbers, and all reach the hundreds of billions. The Department of the Treasury (and therefore tax compliance) accounts for most of the paperwork burden in the federal Information Collection Budget. Yet as noted Treasury’s costs do not appear in the OMB’s annual regulatory benefits and costs reports to Congress. In the “FY 2015 Burden Changes by Agency” chart on page 7 of the Information Collection Budget, Treasury accounts for 7.357 billion of the total 9.778 billion hours, or 75 percent.
With respect to lost efficiencies generated by taxation, an OMB guideline reckons an “excess burden” or deadweight loss associated with federal taxation equals 25 percent of revenues (similar to the Laffer estimate):
“Unless a tax is imposed in the form of a lump sum unrelated to economic activity, such as a head tax, it will affect economic decisions on the margin. Departures from economic efficiency resulting from the distorting effect of taxes are called excess burdens because they disadvantage society without adding to Treasury receipts. This concept is also sometimes referred to as deadweight loss.”
“The presentation of results for public investments that are not justified on cost-saving grounds should include a supplementary analysis with a 25 percent excess burden. Thus, in such analyses, costs in the form of public expenditures should be multiplied by a factor of 1.25 and net present value recomputed.”
The GAO approach noted above includes some efficiency or deadweight costs (in addition to basic compliance and software such as highlighted in the $226 billion estimate from the National Taxpayers Union). GAO reckoned tax compliance and efficiency costs of at least $369 billion, as already noted. With no way of knowing actual indirect costs of taxation, and uncertainty with respect to hourly wage costs, and with the desire throughout to use White House/OMB numbers where possible for framing given their applicability to regulatory costs more broadly, we may note that, assuming $43 an hour on the paperwork cost spectrum (less than the 2008 IRS data regarding business paperwork hours costs but higher than individual costs) yields us a back-of-the-envelope placeholder for Treasury paperwork costs (primarily but not exclusively tax compliance) of $316 billion annually ($43 times 7.357 hours) with no way of knowing the distribution between direct cost and deadweight cost.
I include this figure appears in Principia Bureaucratica: A Placeholder for the Total Annual Cost of Federal Regulation and Intervention (my overall regulatory cost placeholder is $1.9 trillion annually). This estimate could be increased to match the GAO or Tax Foundation or Laffer lower bounds and increased our costs considerably, but I have elected to not do so in keeping with Costberg’s “at least this much” format. Salaries do not encompass all the costs of paperwork, of course; pointing to $43 here is a convenience, even though other costs exist.
Incidentally, the Patient Protection and Affordable Care Act, or the portions of Obamacare that survive, will add “significant complexity” to tax preparation, ending shortcuts like the 1040-EZ form for many who get subsidies among other details.
In his North Dakota speech, Trump singled out tax preparation firm H&R Block as one entity probably not thrilled at the idea of tax simplification. That firm alone has annual revenues of nearly $3 billion.
Know what else is interesting about tax compliance costs of some $300 billion?
It’s the same amount as corporate income tax collections. What a waste.
Originally published to Forbes Online.