The High Costs of the Existing Federal Tax System      

The federal tax system imposes very high costs on the American economy. It’s complex and convoluted structure results in it costing far more than the $5 trillion it extracts annually from taxpayers’ pocketbooks. Each year it effectively imposes hundreds of billions in additional surtaxes on the American people.

Excess Burdens

By far, the largest of these are what economists call excess burdens. These arise because individuals alter their behavior in response to high taxes. Business owners, for example, may choose not to expand their companies due to high marginal tax rates on their income. Similarly, high taxes on investments may induce individuals to put their savings into unproductive tax shelters rather than investing it in ways that lead to more and better products and services. Such activity significantly reduces the size of the overall economy.

Many prominent economists have attempted to estimate the size of existing excess burdens. These estimates vary from around twenty cents per additional dollar of tax collected to over $1.00. In general, researchers find that at current levels of tax, each additional tax dollar collected imposes around 40 cents of additional harm to the economy.

Other Surtaxes

Compliance and administrative expenses also effectively impose surtaxes. Each year Americans file around 270 million tax returns and spend some 7.9 billion hours filling out paperwork and otherwise complying with the federal tax system. The resulting lost productivity and out-of-pocket expenses are estimated to cost the economy around $550 billion annually.

Americans also shoulder the administrative costs of running the Internal Revenue Service as well as other organizations involved with tax administration, such as U.S. Tax Court and the congressional tax writing committees. These costs are relatively modest, adding around $11.5 billion annually to the federal budget.

Compliance and administrative expenses add roughly 10 cents for every federal tax dollar collected. When these are added to the costs imposed by excess burdens we find that removing one federal tax dollar from the economy imposes approximately $1.50 in costs on the society.

To put this figure into context, the Congressional Budget Office estimates that failure to extend the Tax Cuts and Jobs Act would add $4.6 trillion to Americans’ tax bills over the next decade. These estimates imply that, in addition to the increased tax burden, American’s will effectively also bear a $2.3 trillion in additional costs over ten years, in the form of lost economic opportunities if these tax cuts lapse.