No one in America today actually expects the IRS to disappear in the near future. Taxes, like death, are the only certain things in life, or so says the old adage. But what is the true cost of having a complicated tax code that makes the IRS so essential. In 2011, economists Arthur Laffer, Wayne Winegarden and John Childs published a study that examined just that question. What they found was startling.
First, each year, American individuals and businesses pay roughly 32 billion dollars just to have their tax returns prepared by professionals. (This includes the cost of tax software as well as places like H&R Block and accounting firms.) On top of this, the IRS costs another 13 billion dollars to run. The IRS itself estimates that individuals and businesses spent 6.1 billion hours just in connection with the preparation of tax returns and other filing requirements of the tax code. When you add in the cost of gathering documents and other compliance costs, the estimated cost to the economy of complying with the current tax code is estimated to have been 377 billion dollars in 2008. Audits by the IRS cost close to another ten billion dollars per year. This comes to a total cost of $432 billion dollars each year just to comply with the tax code. Remember, none of this cost is revenue to the government; it is the cost of getting the revenue to the government.
Second, each year, Americans also modify their behavior in order to meet the requirements of the tax structure. An elderly man may hold onto a house he no longer needs because to sell would cause a major capital gains tax to be paid while passing the same house to his child through his will would erase that tax burder. All sorts of behaviors are changed across the country to gain tax benefits. What this means is that rather than doing what makes the most economic sense, people and companies are instead doing what makes the most tax sense. The cost of such activity is immense.
Third, all of these expenditures do not add to economic growth. Quite the contrary is true. It is estimated that a 50% reduction in tax complexity would add between 0.45% and 0.9% to the growth rate of GDP each year. That means that at the end of a decade, the per capita income of Americans would be between $2800 and $6000 higher after such a reduction in complexity.
Fourth, none of this takes into consideration the drag put on the economy by the fear of upcoming tax changes. Businesses and people sometimes get frozen into inaction while they wait for the future of the tax law to be clarified. We have all lived through the repeated expirations of "temporary" tax measures, and the uncertainty as to whether or not they will be renewed, ended or changed has prevented a great deal of investment in the economy.
Put all this together, and the impact is staggering. The total cost over the next decade for tax collections comes to almost five trillion dollars. On top of that, the complex tax code limits economic growth by a much larger amount during that same period.
So what can be done? There really is an answer.
1. We cannot abolish all taxes. We need to have a steady stream of income for the government to function.
2. We can, however, abolish the current tax structure. Suppose that instead of the current complicated tax structure, everything was simplified. Suppose there were no deductions of any sort. To be clear, abolishing those deductions would hit a whole host of sacred cows with big lobbies in Washington. There would be no deduction for home mortgage interest, no deduction for state and local taxes paid, no deduction for charitable contributions and no deduction for medical expenses. On top of that change, all income would be subject to taxation. That means that if you get health insurance from your employer, it would be considered income. It also means that if you buy municipal bonds, the interest would be taxed just like with any other bonds. IRA's would also vanish.
3. We can also abolish the current corporate income tax structure. The thousands of pages of laws, regulations and rulings could be thrown out the window and replaced with a relatively simple system that treated every company the same. There would be just one set of rules for depreciation no matter what the asset. There would be no special tax credits or rebates. Corporate activity would be ruled by what made economic sense, not what made tax sense.
4. Tax simplification would not only get rid of the huge cost of collecting the taxes, it would also allow for the drastic reduction in the rate of the taxes. America's corporate tax rate could fall from 35% to something well under 20%. The personal income tax rates could also fall dramatically. Indeed, we could go to a three tier structure of 3%, 10% and something higher (like 20%). There would still be personal exemptions and these could shield the very poor from paying any taxes.
This sort of structure ought to lead to major growth in the economy after some initial dislocation as the distortions from the current tax structure are removed. All the extra cash available to taxpayers would cause major growth in the GDP. Investments in the most economically positive places would also lead to higher growth. Indeed, all this growth would mean that tax revenues themselve would jump quickly to higher and higher levels while expenditures needed for the unemployed and underemployed would fall.
We can get rid of the IRS for the most part. And by doing that, we can cause our country to prosper and grow at a much faster rate than it currently does.
First, each year, American individuals and businesses pay roughly 32 billion dollars just to have their tax returns prepared by professionals. (This includes the cost of tax software as well as places like H&R Block and accounting firms.) On top of this, the IRS costs another 13 billion dollars to run. The IRS itself estimates that individuals and businesses spent 6.1 billion hours just in connection with the preparation of tax returns and other filing requirements of the tax code. When you add in the cost of gathering documents and other compliance costs, the estimated cost to the economy of complying with the current tax code is estimated to have been 377 billion dollars in 2008. Audits by the IRS cost close to another ten billion dollars per year. This comes to a total cost of $432 billion dollars each year just to comply with the tax code. Remember, none of this cost is revenue to the government; it is the cost of getting the revenue to the government.
Second, each year, Americans also modify their behavior in order to meet the requirements of the tax structure. An elderly man may hold onto a house he no longer needs because to sell would cause a major capital gains tax to be paid while passing the same house to his child through his will would erase that tax burder. All sorts of behaviors are changed across the country to gain tax benefits. What this means is that rather than doing what makes the most economic sense, people and companies are instead doing what makes the most tax sense. The cost of such activity is immense.
Third, all of these expenditures do not add to economic growth. Quite the contrary is true. It is estimated that a 50% reduction in tax complexity would add between 0.45% and 0.9% to the growth rate of GDP each year. That means that at the end of a decade, the per capita income of Americans would be between $2800 and $6000 higher after such a reduction in complexity.
Fourth, none of this takes into consideration the drag put on the economy by the fear of upcoming tax changes. Businesses and people sometimes get frozen into inaction while they wait for the future of the tax law to be clarified. We have all lived through the repeated expirations of "temporary" tax measures, and the uncertainty as to whether or not they will be renewed, ended or changed has prevented a great deal of investment in the economy.
Put all this together, and the impact is staggering. The total cost over the next decade for tax collections comes to almost five trillion dollars. On top of that, the complex tax code limits economic growth by a much larger amount during that same period.
So what can be done? There really is an answer.
1. We cannot abolish all taxes. We need to have a steady stream of income for the government to function.
2. We can, however, abolish the current tax structure. Suppose that instead of the current complicated tax structure, everything was simplified. Suppose there were no deductions of any sort. To be clear, abolishing those deductions would hit a whole host of sacred cows with big lobbies in Washington. There would be no deduction for home mortgage interest, no deduction for state and local taxes paid, no deduction for charitable contributions and no deduction for medical expenses. On top of that change, all income would be subject to taxation. That means that if you get health insurance from your employer, it would be considered income. It also means that if you buy municipal bonds, the interest would be taxed just like with any other bonds. IRA's would also vanish.
3. We can also abolish the current corporate income tax structure. The thousands of pages of laws, regulations and rulings could be thrown out the window and replaced with a relatively simple system that treated every company the same. There would be just one set of rules for depreciation no matter what the asset. There would be no special tax credits or rebates. Corporate activity would be ruled by what made economic sense, not what made tax sense.
4. Tax simplification would not only get rid of the huge cost of collecting the taxes, it would also allow for the drastic reduction in the rate of the taxes. America's corporate tax rate could fall from 35% to something well under 20%. The personal income tax rates could also fall dramatically. Indeed, we could go to a three tier structure of 3%, 10% and something higher (like 20%). There would still be personal exemptions and these could shield the very poor from paying any taxes.
This sort of structure ought to lead to major growth in the economy after some initial dislocation as the distortions from the current tax structure are removed. All the extra cash available to taxpayers would cause major growth in the GDP. Investments in the most economically positive places would also lead to higher growth. Indeed, all this growth would mean that tax revenues themselve would jump quickly to higher and higher levels while expenditures needed for the unemployed and underemployed would fall.
We can get rid of the IRS for the most part. And by doing that, we can cause our country to prosper and grow at a much faster rate than it currently does.
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