THE COSTS OF TAX
COMPLEXITY
Presentation to the President’s
Advisory Panel on Federal Tax Reform
Joel Slemrod
March 3, 2005
The Resource Cost of Collecting Taxes

The IRS budget: administrative costs.

The time and money spent by taxpayers
and third parties: compliance costs.

The latter dwarfs the former, which is
about $10 billion annually.
How Big Are Compliance Costs?
 Individuals: $85 billion. This includes the value
of 3.5 billion hours of time, the equivalent of
nearly two million hidden IRS employees—we
the taxpayers.
 Businesses (other than sole proprietorships):
$40 billion.
 Total: $125 billion. This comes to nearly 13
cents per dollar of income tax receipts, and is
more than 12 times higher than the IRS
budget. The cost ratio has probably, but not
certainly, grown in the last two decades.
The Nature of Compliance Costs
 Almost two-thirds of the cost is due to
recordkeeping.

Costs are highly concentrated. Forty million
taxpayers spend five hours or less per year.

Compliance costs rise with taxpayers’ income and tax
liability, but less than proportionately: compliance costs
are regressive.

Costs are particularly high for self-employed
taxpayers.

Tax software reduces the difficulty of filling out
forms and doing calculations, but does not
reduce the burden of recordkeeping.
Other Costs of Tax Complexity
 Complexity causes a capricious and often
uncertain distribution of tax burdens. Even
professionals often disagree about the tax
liability.
 It rewards those who have the means and
inclination to find all the angles.
 It undermines trust in the fairness of the tax
system, which may in turn undermine voluntary
compliance.
 It reduces the transparency of the tax system.
Why Is It So Complex?
 It reflects a belief that simpler, or less
conscientiously enforced, systems cause an
unfair distribution of the tax burden.
 The tax system is an awkward mixture of a
revenue-raising system plus scores of incentive
and reward programs.
 Income (and especially capital and corporate
income) is often inherently difficult to measure,
leading to inconsistencies that reward
complicated transactions such as tax shelters
and tax-oriented financial products.
Evidence from Other Countries

Only 6 countries in history have operated RSTs
at rates of 10 percent or more; none do now.

The cost-revenue ratio of European VATs ranges
from 3 to 5 percent.

The cost-revenue ratio for European income
taxes is apparently not much higher than for
their VATs, and is much lower than for the U.S.
income tax; reliable comparable statistics are,
however, scarce.
What Are the Keys to Simplifying
the Tax System?
 Resist fine-tuning the tax liability of individuals.
 Resist fine-tuning the economy by subsidizing
and rewarding activities deemed to be
especially valuable.
 Simplify sufficiently to take advantage of largescale withholding by business, either radically
as in a VAT or through a return-free income tax
system.
What Are the Tradeoffs to Be Faced
in Simplifying the Tax System?

Simpler business-based taxes like the VAT
involve a massive redistribution of tax burden
away from high-income to low-income
families.

Simplifying the tax base restricts activist
government and requires settling for rough
justice.

Nothing simplifies the tax system without also
affecting equity and efficiency.

Transition to an even simpler new system will
entail one-time costs as new rules are
assimilated.
Appendix: Are There Simpler
Alternatives?
 The retail sales tax seems simpler, but at the
revenue-neutral tax rate would not be
administrable at our usual standard of equity and
intrusiveness.
 A value added tax is administratively more
robust, and could cut compliance costs
significantly if it replaced the income tax.
 A true flat tax could cut compliance costs in half,
but facilitates the reintroduction of complicating
incentive and reward programs.
Appendix Table 1
Details of Recent Estimates of the Collection Cost of the
U.S. Income Tax System
Slemrod (1996)1
TY1995
IBM (2003)2
TY2000
Slemrod (2004)3
TY2004
Hours (bil.)
2.8
3.21
3.5
Average value per hour ($)
15.0
20.0
20.0
Value of hours ($ bil.)
42.0
64.2
70.0
Expenditures ($ bil.)
8.0
18.8
15.0
Total resource cost ($ bil.)
50.0
83.0
85.0
Individuals
All businesses, other than sole
proprietorships
Hours (bil.)
0.8
Average value per hour ($)
25.0
Total resource cost ($ bil.)
20.0
(continued on next slide)
40.0
Appendix Table 1 (continued)
Details of Recent Estimates of the Collection Cost
of the U.S. Income Tax System
Slemrod (1996)1
TY1995
IBM (2003)2
TY2000
Slemrod(2004)3
TY2004
Total compliance cost ($ bil.)
70.0
125.0
Total administrative cost ($ bil.)
5.0
10.0
Total collection cost ($ bil.)
75.0
135.0
Ind. income tax receipts ($ bil.)
590.2
1004.5
809.0
Corp. income tax receipts ($ bil.)
157.0
207.3
189.4
Total income tax receipts ($ bil.)
747.2
1211.8
998.4
Total collection cost as a % of total
income tax receipts
10.0
13.5
Appendix Table 1 (continued)
Details of Recent Estimates of the Collection Cost of the
U.S. Income Tax System
Notes to table: All dollar figures are in current dollars. The tax receipts figures refer to fiscal
years, and are taken from Economic Indicators, December 2004 (U.S. Government Printing
Office, Washington, D.C.).
Slemrod (1996) refers to detailed estimates discussed in my article entitled “Which Is the
Simplest Tax System of Then All?” published in H. Aaron and W. Gale (eds.), The Economics of
Fundamental Tax Reform, The Brookings Institution, 1996, pp. 355-91.
1
2
IBM (2003) refers to the IBM Business Consulting Services contract work with the IRS,
discussed in Guyton, John L., John F. O’Hare, Michael P. Stavrianos, and Eric Toder, “Estimating
the Compliance Cost of the U.S. Individual Income Tax,” National Tax Journal (September, 2003),
pp. 673-88.
3
Slemrod (2004) refers to written testimony submitted to the Committee on Ways and Means,
Subcommittee on Oversight, Hearing on Tax Simplification, Washington, D.C., June 15, 2004.
Only the tax receipts numbers have been updated from that testimony.