It’s widely known that the federal tax code is seriously flawed. Unfortunately, the general public isn’t aware of the extent to which the tax code harms the health of the national economy, which is preventing a serious national discussion about much needed tax reform. In the following paragraphs, you will learn the true costs of the tax code, and what can be done to change it for the better. Here are three things everyone needs to know about the US tax code:
1. It Is Painfully Inefficient
It’s no secret that the United States tax code is tremendously long and convoluted. According to CCH Standard Federal Tax Reporter, the tax code has grown from 400 pages in 1913 to a whopping 73,954 pages in 2013. One has to wonder, has anyone tried to estimate the cost of simply complying with the tax code?
The answer is yes. A 2005 study by the Government Accountability Office (GAO) reported that the compliance and efficiency costs associated with the federal tax system are large (which is an understatement). When analyzing the compliance costs of the tax system, the study noted that the lowest available estimates suggest that the cost of individual and corporate compliance with the tax code was $107 billion (which was around 1 percent of GDP in 2005). As noted, this is a low estimate. The Cato Institute estimates that the cost of compliance is roughly $200 billion annually, whereas Art Laffer (famous for pioneering the Laffer Curve), estimates it to be $431 billion annually.
On top of that, the GAO finds that the most comprehensive studies on the efficiency costs associated with the U.S. tax code estimate such costs to be around 2 to 5 percent of GDP (as of the mid-’90s), which is around $200-$500 billion after adjusting for inflation.
This is simply embarrassing. Instead of using that money for consumption or investment, American citizens and businesses are wasting hundreds of billions of dollars in both compliance and efficiency costs on the U.S. tax code, which necessarily implies that our economic standard of living would be significantly higher if these costs were absent or at least reduced.
2. It Punishes the Most Beneficial Economic Activities
Any pro-growth tax system would be constructed to avoid taxing economically beneficial activities like work and investment. Unfortunately, the brilliant designers of the current tax code decided to do the complete opposite. The bulk of federal revenue, 57 percent to be exact, comes in the form of income taxes on individuals and corporations. At this point, given the inefficiency of the tax code, the reader will be unsurprised to find out that researchers from the Organisation for Economic Co-operation and Development have found that corporate taxes are most harmful to economic growth, followed by personal income taxes, then consumption taxes, and lastly property taxes.
This is because personal income taxes lessen the returns on productive behavior, thus discourage it, and corporate taxes reduce the incentive to invest domestically, as has been highlighted by Pfizer Inc.’s recent actions to base their company in Britain in order to take advantage of the country’s lower corporate tax rate.
Taxing consumption is a simpler and less distortionary way to raise revenues since it does not discourage productivity or investment like other taxes do, nor does it have tax loopholes which benefit a select few like the current system does. It’s no wonder why economists of different ideologies favor the replacement of income and payroll taxes with progressive consumption taxes and studies which estimate the effects of such a change find that it would significantly increase economic growth, employment, domestic investment, and disposable income for workers over the current system.
3. It’s Greedy
The idea that the federal government takes too much from the people in the form of taxes is something both conservatives and libertarians tend to agree on simply because that’s how their philosophies align. Today’s liberals on the other hand see taxation as a means to achieve the goals they wish to impose on the populace as a whole. From a purely economic standpoint, adherence to which philosophy is more desirable?
Well, according to research from Christina Romer, one of the leading Keynesian economists behind the 2009 federal stimulus, a 1 percent increase in taxation as a share of the economy shrinks the economy by roughly 3 percent in the U.S. (mainly by displacing private investment). Additionally, Swedish economists have recently reported that the vast majority of research finds that both taxes and government spending are significantly negatively associated with economic growth in rich countries after controlling for numerous other confounding factors.
Thus, there is good reason to believe that current levels of government spending and taxation are detrimental to the economic growth and that these levels need to be reduced rather than increased.
To the people who believe universal health care and wealth redistribution are worth the cost of a slower economic growth rate consider this fact: An annual growth rate of 2 percent means that the economic standard of living of a country doubles in thirty-six years. But if the annual growth rate is instead 3 percent, a doubling of the standard of living takes only twenty-four years. Ultimately, how fast a country’s economy grows determines how rich it will become.