May 28, 2013

The High Costs of a Terrible Tax Code

Jason J. Fichtner

Former Senior Research Fellow

Jacob Feldman

Summary

Washington has long used the federal tax code to advance objectives ranging from increasing "fairness" to granting a competitive advantage to favored businesses or industries. But riddling the code with special provisions has a price beyond the revenue lost from the tax breaks themselves.

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Washington has long used the federal tax code to advance objectives ranging from increasing "fairness" to granting a competitive advantage to favored businesses or industries. But riddling the code with special provisions has a price beyond the revenue lost from the tax breaks themselves.

In a new Mercatus Center study, "The Hidden Costs of Tax Compliance," we document the costs and implications of the grossly complex U.S. tax system.

The Treasury forgoes approximately $450 billion per year in unreported taxes. Worse, Americans face up to nearly $1 trillion annually in hidden tax-compliance costs. And according to the IRS, taxpayers spent more than six billion hours in 2011 complying with the tax code – that's enough to create an annual workforce of 3.4 million people. If that workforce was a city, it would be the third largest city in the United States. If that workforce was a company, it would employ more individuals than Walmart, IBM, and McDonalds, combined.

The complexity of the tax code also creates an uneven playing field for taxpayers.

About one-third of U.S. taxpayers itemize deductions. This increases the costs of filing taxes and distorts the costs of goods and services ranging from homes to medical care. These deductions also benefit those at the higher end of the income spectrum, as less than 15 percent of households with earnings below the U.S. annual median income file an itemized tax return.

Also, specialized tax incentives favor larger, more established firms. Smaller businesses often are unable to take advantage of provisions such as tax deductions for interest payments and debt financing, and often lack the resources and scale to comply with a complicated depreciation schedule for capital investments.

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