Professor Joel Slemrod Gives Testimony to President's Tax Reform Panel
Renowned tax expert addresses the costs of tax complexity.
ANN ARBOR, Mich.—Joel Slemrod, professor of business economics and public policy at the Stephen M. Ross School of Business at the University of Michigan, presented testimony to the President's Advisory Panel on Federal Tax Reform March 3 in Washington, D.C.
In his testimony, "The Costs of Tax Complexity," Slemrod explained that the annual IRS budget (administrative costs) of $10 billion is small compared to annual compliance costs (time and money spent by taxpayers and third parties) of $125 billion.
According to Slemrod, almost two-thirds of compliance costs are due to record-keeping and those costs rise with taxpayers' income and tax liability, but less than proportionately. He also said costs are particularly high for self-employed taxpayers and that while tax software reduces the difficulty of filling out forms and doing calculations, it does not reduce the burden of record-keeping.
Slemrod described additional consequences of tax complexity, including an inconsistent distribution of tax burdens; rewards for those who have the means and inclination to find all the angles; a mistrust in the fairness of the tax system, which may in turn undermine voluntary compliance; and a reduction in the transparency of the tax system.
As for what leads to tax complexity, he said the tax system is an awkward mixture of revenue-raising and scores of subsidy and reward programs. It reflects a belief that simpler or less conscientiously enforced systems cause an unfair distribution of the tax burden. Furthermore, income (especially capital and corporate) is often inherently difficult to measure, leading to inconsistencies that reward complicated transactions such as tax shelters and tax-oriented financial products, he said.
Slemrod also discussed tax systems in other countries, saying that only six countries in history have operated retail sales taxes (RST) at rates of 10 percent or more, but none currently do now. He said the cost-revenue ratio of European value added taxes (VAT) ranges from 3-5 percent and the cost-revenue ratio for their income taxes is not much higher—but much lower than the U.S. income tax.
The keys to simplifying the tax system include resisting fine-tuning both the tax liability of individuals and the economy by subsidizing and rewarding activities deemed to be especially valuable, and making it easier to take advantage of large-scale withholding by business, either radically with a VAT or through a return-free income tax system.
According to Slemrod, any tax reform that addresses tax complexity must address certain tradeoffs. Simpler, business-based taxes like the VAT involve a massive redistribution of tax burden away from high-income to low-income families. Achieving more simplicity restricts activist government and requires settling for rough justice. Finally, the transition to a simpler tax system may include a substantial one-time cost as new rules are assimilated.
Slemrod's testimony concluded with the exploration of simpler alternatives. He said the RST seems simpler, but at the revenue-neutral tax rate of 30 percent or more, it could not be administrated at our usual standard of equity and intrusiveness. Also, a VAT is administratively more robust than an RST and could cut compliance costs significantly if it replaced the income tax. A true flat tax could cut compliance costs in half, but would facilitate the reintroduction of complicating incentive and reward programs, he said.
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