Saturday, December 10, 2005

Those taxing taxes

The IRS finally came out and told America what it estimates the average filer pays out-of-pocket to pay, well, out-of-pocket to the IRS (subscription required):
"These new estimates were developed to help people get a better understanding of
the burden of preparing their taxes... The IRS is required by law to provide taxpayer-burden estimates."
For form 1040 only, the estimated cost comes in at $121. If schedule A (itemized deductions) and schedule D (capital gains) are included--these are generally more affluent taxpayers, as only 30% of filers itemize--the average is $313. Given that there are 78.8 million filers who pay to have their taxes done, these estimates yield a grand total a few million over $14 billion. Prodigious as that number seems, it is pittance in the scheme of US tax-compliance costs:
"In 2002 individuals, businesses and non-profits will spend an estimated 5.8 billion hours complying with the federal income tax code (henceforth called “compliance costs”), with an estimated compliance cost of over $194 billion. This amounts to imposing a 20.4-cent tax compliance surcharge for every dollar the income tax system collects. By 2007, the compliance cost is estimated, conservatively, at $244.3 billion. However, this estimate does not take into account the recently enacted Economic Growth and Tax Reform Reconciliation Act (EGTRRA) of 2001. Taking EGTRRA into account shows that the compliance cost could soar as high as $350.2 billion by 2007."
The IRS estimates are only looking at the accounting cost and only for individual filers, as opposed to the economic cost imposed on all entities that have to file (businesses outspend individuals by about 20%). Accounting cost consists of actual dollars (or equivalents) paid, while economic cost incorporates opportunity costs into the mix. That some 5.8 billion hours--or 662,100 years--of wasted time means over 662 millenia worth of Joe American's productivity is discarded every year (increasing perennially) in addition to the actual dollars forked over to tax preparers.

And even this more broadly encompassing estimate is only the tip of the iceberg. What about estate planners, huge CPA firms (445,000 employees at the big four alone), tax attornies, and collection agents involved in avoiding and extracting taxes, respectively? Accountants and attornies are among the select group of high-IQ professions. What are these people, the vast majority of whom have IQs surpassing 120, doing to contribute to human progress? Playing in a perpetual chess match against other high-IQ types on the IRS's 99,000-strong, $10.185 billion annual budget side! What a colossal waste. When their opportunity costs are taken into consideration from the perspective of society at large (not the professional's individual opportunity costs, as they are obviously being remunerated handomsely for their services), the tax system-induced loss must be unfathomably astronomical.

The IRC must be seriously reformed. We need something more drastic than shaving a few lines off the 1040 and collapsing six income brackets into four--these proposals are a step in the right direction, but only a marginal one.

I favor a national sales tax to replace the federal income tax, since the US is a consumption-based society. One of the tenets of an ideal tax system is the so-called "wherewithal to pay"--that is, people should only have to pay tax when they have the money to do so (think if you were taxed at the end of the year for the gain in your stock holdings, even though you hadn't sold them--if a significant amount of your investments were in the market, coming up with the cash flow to pay the IRS could become very burdensome).

A sales tax does that--you only pay tax when buying a new product or service. It would generally be progressive in nature, as people with more disposable income tend to spend more, in absolute terms anyway. Under the FairTax plan (23%), all citizens would receive a credit equal to the poverty line for their situation on a monthly basis. Thus, people spending an amount under the poverty threshold would skate tax-free. A national sales tax would also encourage conservation, since only new items would be subject to the tax and it would make the US an even more attractive location for corporations to emigrate to since they would not have to pay based on profits but instead on capital expansion. It would also eliminate every free-marketers favorite object of derision--double taxation.

The flat tax is another option. While it would not fundamentally alter the way the tax system works, the most popular proposals call for an end to deductions and credits in addition to differing tax rates. This would eliminate the need for tax preparation and make tax shelters orders of magnitude more difficult to pull off. With a poverty credit similar to that of the national sales tax, some of the inevitable criticism of its inherent 'unfairness' (since it's equal and all) in not increasing the tax rate in tandem with income would be parried. Steve Forbes thinks he can do it at just 17%.

While intuitively it appears that higher tax rates lead to higher government revenues, it's far from settled. For example, with the Bush tax cuts still firmly in place, 2005 is going to be the highest grossing year on record (p30) for the US government, and the fourth highest when adjusted for inflation. Conceptually, think of two extreme scenarios: Country A taxes its citizens at 5% of income. Country B taxes its citizens at 95% of income. All other things equal, which government do you think pulls in more revenue (while having an exponentially larger and more dynamic economy)?

The slew of time, energy, and manpower (not to mention frustration) that goes into the current tax system can conceivably be avoided rather easily. But every tax change is going to have its winners and losers--and usually it's the potential losers who scream the loudest. The masses need to wake up to this waste and realize it can be fixed.



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Anonymous said...

Great blog!