Professor Joel Slemrod Gives Testimony to U.S. House of Representatives
Renowned tax expert addresses the Committee on Ways and Means.
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 U.S. House of Representatives Committee on Ways and Means June 8 in Washington, D.C.
Slemrod was one of five tax policy experts who spoke at the hearing in an effort to improve the current tax system while keeping it fair and simple. In his testimony on tax reform, Slemrod addressed the cost of collecting taxes under the current system, what causes this cost, and what kinds of tax reform promise to simplify and reduce the cost of collecting taxes.
According to Slemrod, the current tax code costs $125 billion and 3.2 billion hours a year to comply with. This translates into an average burden of 25.5 hours and $149 per taxpayer.
Slemrod also said that although self-employed taxpayers (59.5 hours, $363) represent only about 25 percent of all individual taxpayers, they experienced approximately 60 percent of the time and money burden resulting in a substantially greater tax burden than that of taxpayers with only wage and investment income (13.8 hours, $75).
He said the average compliance burden was also consistently higher among taxpayers who have a more complex tax return and gave the example that non-self-employed taxpayers who itemize their returns spend an average of 21 hours and $114 on tax compliance, compared with 11 hours and $63 for non-itemizers.
Slemrod's testimony also stated that this system is not complicated for everyone, with survey evidence suggesting that 30 percent of taxpayers spend fewer than five hours on all tax matters over an entire year.
"By applying a range of dollar values to each hour of time burden, the annual resource cost of compliance for individual taxpayers is between $67 billion and $99 billion," he said.
Slemrod discussed the consequences of tax complexity beyond what can be estimated in dollars. He said it causes inconsistent and unfair distribution of tax burdens because it rewards those who have the means and inclination to find all the tax angles, and "leaves the dutiful among us holding the bag."
In addition, Slemrod said complexity causes mistrust in the fairness of the tax system, which may in turn undermine voluntary compliance. "Complexity reduces the transparency—who bears how much burden and why—of the tax system, which I believe is inimical to a properly functioning democracy," he said.
He also discussed the rapid computerization of taxes saying that in 2003, over two-thirds of self-prepared returns were done with computer software, compared to less than 20 percent in 1993.
"Although it has undoubtedly facilitated the tax collection process, I am concerned that computerization also may erode taxpayer understanding of the formula that turns the inputted items into what one owes the government," he said. "Tax return software may be helping to turn the tax system into a black box—a more efficient black box, to be sure, but a black box nevertheless."
Slemrod stressed that we must move beyond shallow support for simplification and address how, and how much, to simplify the tax system. He said it is imperative to separately consider three important aspects of the tax system—rate structure (including whether the rate structure has one rate for all or is graduated), base integrity (whether the base is messy or clean) and base choice (whether the base is income or consumption, or something in between.)
"Another fundamental point is that the simplest way to collect tax is not the best, and there are almost always tradeoffs between simplicity and the other criteria we use to evaluate our tax system," said Slemrod.
Can a messy tax base be justified by an appeal to fairness? "In some cases, yes," said Slemrod.
"But most of the deductions, credits and adjustments in our current system cannot be justified in this way. The fact is that the U.S. income tax system is an awkward mixture of a revenue-raising system plus scores of incentive and reward programs," he said.
He went on to state that cleaning the tax base may be the hardest aspect of tax reform to achieve politically, because nearly every bell and whistle has a constituency behind it.
"One key to simplifying the tax system follows from the causes of tax complexity: minimize fine-tuning the tax liability of individuals and fine-tuning the economy by subsidizing and rewarding activities deemed to be especially valuable.
"Simplifying the system enough along these dimensions would allow us to take advantage of large-scale final withholding by businesses through a return-free income tax system," he said.
He added that with significant base cleaning, as many as two-thirds of individual taxpayers would not need to file tax returns at all.
"Thus, base cleaning alone can, for the majority of taxpayers, achieve the ultimate simplification—no return at all—that is a natural feature of either a value-added tax or a retail sales tax," he said.
Slemrod emphasized that this is a "populist" simplification, in that it would simplify the system for the many people whose tax matters are already relatively simple.
He also addressed structural changes to the way we now tax corporations saying they also have the potential to simplify the tax system.
Slemrod said this type of reform, called integration, has long been advocated by supporters of a comprehensive income tax base, and is not inherently related to a consumption versus income tax base.
"Although abandoning progressivity or thoroughly cleaning the tax base would to my mind certainly qualify as fundamental reform, in recent years the idea of fundamental reform has become linked to basing taxation on consumption rather than income," he said.
Do we need fundamental reform in this sense to get a less complex system? Not according to Slemrod, who said that replacing the income tax with a consumption base is neither necessary nor sufficient for significant tax simplification.
"Adopting a consumption tax is not necessary for simplification because a clean-base, largely return-free, structurally improved income tax system can achieve a lot," he said.
However, he doesn't dismiss the potential inherent simplicity advantages of this solution. "All other things equal, and with some exceptions, tax systems are simpler when the base is cleaner, when the rate structure is flatter, and when the base is consumption."
Slemrod said we should not fall victim to the "grass is greener" fallacy surrounding consumption taxes and that with more than a trillion dollars at stake, plenty of people will be looking for inconsistencies in the system.
"Consumption taxes based on taxing retail sales are probably not administrable at our usual standards of equity and intrusiveness," he said. "Depending on how it is handled, the transition to any consumption tax system, even one that eventually would be much simpler, can be incredibly complex and riddled with loopholes that erode both revenues and fairness."
In closing, Slemrod said the potential benefit from tax simplication is substantial, but choosing the right path to a simpler system requires facing up to several difficult tradeoffs.
"This should not be surprising, because dealing with tax complexity requires addressing the most fundamental questions about the relationship between government and the people it serves: how activist should the government be, how intrusive should it be and when should it settle for rough justice?"
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