COSTS OF THE FEDERAL TAX SYSTEM

October 19, 2005

In 2005, Americans will pay about $2.1 trillion in combined federal taxes. However, the amount of taxes paid does not reflect the total cost to taxpayers -- taxpayers also bear compliance and efficiency costs, according to a new study by the Government Accountability Office.

Combining the lowest available compliance estimates for the personal and corporate income tax yields a total of $107 billion (roughly 1 percent of GDP) per year. The GAO says estimating efficiency costs are very challenging because the tax system has extensive and diverse effects on behavior.

To gain a more comprehensive view of efficiency costs, the GAO looked at estimates of the effects of specific taxes and the overall tax system by several economists, including a National Center for Policy Analysis study by Senior Fellow Andrew J. Rettenmaier. Rettenmaier and his colleague Liqun Liu calculated the economic burden of Social Security payroll taxes using two estimates of labor supply responsiveness. They found:

  • Estimated efficiency costs, which recur every year, ranged from $49 billion to $82 billion in 2001.
  • The estimates do not include impacts of payroll taxes on savings decisions or tax-preferred consumption.
  • They suggest an alternative derivation of the excess burden, which produces estimates that are 10 to 50 percent of the original.

The NCPA study only covered the economic effects of the Social Security payroll tax. Comprehensive studies of the efficiency costs of the total tax system are large -- 2 to 5 percent of gross domestic product (GDP) each year (as of the mid-1990s).

The GAO says the goal of tax policy is not to eliminate compliance and efficiency costs but to design a tax system that produces the desired amount of revenue and balances the minimization of these costs with other objectives, such as equity, transparency and administrability.

Source: U.S. Government Accountability Office, "Tax Policy: Summary of Estimates of the Costs of the Federal Tax System," August 2005; and Liqun Liu and Andrew J. Rettenmaier, "The Economic Cost of the Social Security Payroll Tax," National Center for Policy Analysis, Policy Report No. 252, June 2002.

For GAO text:

http://www.gao.gov/new.items/d05878.pdf

For NCPA text:

http://www.ncpa.org/pub/st252/

 

Browse more articles on Tax and Spending Issues