Tax Simplification: How costly is complexity?
If policymakers knew how much a given change in the tax code would raise or lower taxpayers’ compliance costs (and government’s administrative costs), they could more easily evaluate the trade-offs between complexity and other goals. But complexity and its costs are hard to quantify. Calculating the total resource costs of the current tax system requires dividing those costs into several components: the value of the time it takes individuals and businesses to comply with the tax system, the out-of-pocket costs they incur (for recordkeeping, outside tax preparation, and the like), and the administrative costs borne by government. A number of surveys have tried to measure the burden of tax compliance. Although results vary, most surveys find that the average taxpayer devotes relatively little time to paying taxes, but that a small subset of taxpayers (many of them high-income and self-employed individuals) devote much more.
- One recent study estimated that taxpayers spent 3.2 billion hours and $18.8 billion preparing and paying taxes in 2000. These figures correspond to an average of 25.5 hours and $149 per taxpayer, although these estimates varied by complexity of tax form. Taxpayers filing a 1040EZ, a simplified tax form, spent an average of just 8.1 hours and $17 per return, while taxpayers filing the more complex 1040 form spent an average of 33.8 hours and $205 per return.
- In 1998, 38 percent of taxpayers filed a simplified version of the standard 1040 form, either the 1040A or the 1040EZ. Another 8 percent were eligible to file using these simple forms but elected to file a 1040 form instead. Another 6 percent had to use the 1040 but did not itemize deductions, claim capital gains or losses, or have business income.
- Another study found that although the average taxpayer reported spending 27.4 hours on filing income tax returns and related activities, 30 percent spent less than 5 hours, and 15 percent spent between 5 and 10 hours. At the high end, 11 percent spent 50 to 100 hours, and 5 percent spent more than 100 hours. Out-of pocket costs averaged $111 (in 2007 dollars), but 49 percent of filers had no such costs, and another 17 percent had costs below $84 (in 2007 dollars). Slightly over 7 percent of taxpayers spent more than $337 (in 2007 dollars). High-income and self-employed taxpayers spent the most time and money preparing their taxes.
- Information on the use of paid preparers gives further hints about how complex individuals find the system to be. In 1998, 53 percent of tax filers used paid preparers. Among those who filed the 1040, 64 percent used preparers. Even among 1040A and 1040EZ filers, 35 percent used preparers. It is unclear, however, whether these figures indicate that individuals are using paid preparers because they cannot navigate the tax code themselves, or whether they simply prefer to pay others to do their taxes.
- The IRS currently uses the ADL models to estimate the time required to complete forms and schedules. These estimates are published with the tax forms as part of the Paperwork Reduction Act Notice. For fiscal 1997, the Office of Management and Budget estimated that taxpayers needed 5.3 billion hours to comply with the requirements of all tax forms and Internal Revenue Service regulations. This estimate applies to both businesses and individuals and includes all federal taxes, not just income taxes.
- Using these and other estimates of hours spent, several notable studies have placed the dollar cost of taxpayer time within a range of $103 billion to $380 billion (in 2007 dollars), although the higher end of the range likely overstates the true cost. Adjusting for methodological issues and indexing for inflation yields a realistic range of taxpayer compliance costs of between approximately $105 billion and $175 billion annually, in 2007 dollars. New developments in taxpayer compliance, such as electronic filing, suggest that a new survey is needed to accurately measure the cost today of complying with the tax code.