The federal income tax is a grossly inefficient revenue system. In 1991, for example, businesses spent three-fourths as much to comply with the tax laws as they paid in actual tax. The compliance burden is especially heavy on small corporations, even though only 0.16 percent of corporations paid three-quarters of all corporate income taxes in 1991.

• Corporations with assets of $1 million or less (more than 90 percent of all corporations), paid a minimum of $382 in compliance costs for every $100 they paid in income taxes ($14 billion in compliance costs for $3.7 billion in income taxes).

• That represents about 90 percent of compliance costs for all corporations — and about 4 percent of all corporate income taxes.

• Corporations with $250 million or more in assets paid about $3 in compliance costs for each $100 they paid in income taxes.

Generally speaking, the income tax provisions that generate the highest compliance costs are the rules for depreciation (and the accompanying Alternative Minimum Tax) and the rules on income from foreign sources. Both provisions were part of the Tax Reform Act of 1986. The act began as an effort to simplify taxes, but its provisions increased the cost of compliance by at least 10 percent.

An income tax system is one of the most complex of all tax systems. But the U. S. income tax code has become more complex as it has grown dramatically over the past 40 years.

• Since the Internal Revenue Act of 1954, 31 major tax enactments and more than 400 other public laws have amended the Internal Revenue Code.

• The income tax code has grown from 103 sections to 698 sections and, on average, each section has been amended every four years.

• The number of words in the income tax laws and regulations has grown 647 percent, from 744,000 to over 5.5 million.

Short of overhauling the entire tax system, Congress could work to reduce the complexity and cost of compliance. Less frequent changes would make the tax code more stable. Congress could also place a larger emphasis on tax simplicity instead of trying to shut off all avenues of tax avoidance without regard to the incremental costs or unintended consequences.

Source: Arthur P. Hall, "The Compliance Costs and Regulatory Burden Imposed by the Federal Tax Laws," Special Brief, January 1995, Tax Foundation, 1250 H Street, NW, Suite 750, Washington, DC 20005, (202) 783-2760.

ea mj 95b