With a Senate vote on the tax bill expected soon, a timely new study shows that tax compliance costs are substantial, and a simpler tax code would lower the amount of time and money that people have to spend on their taxes each year. Americans spent more than 8.9 billion hours dealing with tax filing requirements in 2016, and the Tax Foundation estimates the associated costs are more than $400 billion. The lesson: Congress should press ahead with simplification as part of reform.
A new National Bureau of Economic Research working paper provides some additional insight into the substantial costs of tax complexity. In the paper Philippe Aghion and Stefanie Stantcheva of Harvard University, Ufuk Akcigit of the University of Chicago, and Matthieu Lequien of the Banque de France estimate that tax simplicity has a value of up to 650 euros per year per person for the group of French filers they examine. They also find that the costs of tax complexity are regressive, in that the burden is disproportionately borne by those people with less education or lower income.
Their findings shed more light on the reasons why a simpler tax code should continue to be one of the goals of tax reform: simplifying the tax code would reduce these burdens and more resources could be put to productive use.
The bills in the House and Senate would simplify the code in a broad variety of ways. Both bills would significantly increase the standard deduction, which would reduce the number of filers who choose to itemize. The Alternative Minimum Tax would also be repealed, and the estate tax would be either scaled back or repealed. Some of the differences between the House and Senate bills still have to be sorted out, and it is not yet clear what will happen to some provisions. The goal of simplification should be considered in these negotiations.
In the paper, the authors look at French tax return data from 1994 to 2012 for self-employed people, because this group can react more quickly to tax incentives, and their adjustments more directly reflect their personal understanding of the tax system. Aside from the data being available, the researchers use France because it has a number of different “tax regimes” for the self-employed that differ not by the tax rate, tax structure, and degree of simplicity.
The “standard regime” has the most complexity, and treats an individual’s net business income as taxable income. The “simplified regime” allows an individual to claim a flat-rate rebate as a fraction of revenues. The “super simplified regime” goes even further by replacing income taxes and social insurance contributions with a flat-rate payment based on gross revenues. To qualify for the latter two regimes revenues have to be below a certain threshold. The thresholds vary by type of business activity and have changed over time.
France enacted two policy changes that allow the authors to analyze filer responses, learning over time, and provide an estimate for the value of tax simplicity. A 1999 reform significantly increased the eligibility threshold for the simplified regime, and a 2008 reform created the super simplified regime.
The group of self-employed filers responded significantly to notches in the different eligibility thresholds for the different regimes. The authors find evidence of “bunching” just below the thresholds for the non-standard regimes, as filers endeavor to maintain their eligibility.
While the parameters and incentives of the tax structure are important, the authors also find “preferences for tax simplicity to be relatively large and important,” in part because they are more salient to filers. The authors estimate the value of the preference for tax simplicity to be in the range of 160 to 650 euros per year, varying by year and tax regime.
Furthermore, they find that people with higher skill, education, and income are more responsive to tax regime changes and learn faster about the correct adjustments. High-skill filers, those who were licensed professionals, teachers, engineers or executives, chose the correct tax regime more than 34 percent of the time, compared to fewer than 29 percent for low-skill filers. With the incorrect tax regime, filers inadvertently leave money on the table, or use more resources for compliance.
The authors consider whether real economic frictions could explain differences in adjustment behavior, but rule it out. If high fixed costs of switching were the impediment, the more rapid adjustment by more-educated or higher-skill filers is difficult to explain. In addition, switching costs for the 2008 reform creating the super simplified regime were designed to be little more than checking a different box at filing, and the potential financial ramifications of making the incorrect regime choice were significant.
The effects of the incentives and deterrents embedded in the tax code have been studied extensively, and their importance long recognized, but tax complexity is also important. The lessons for the United States that can be drawn from the new working paper are subject to limitations because the data are French and cover a specific subset of filers. However, the broader findings are relevant for Congress’s work on tax reform. Tax complexity influences decisions and can impose substantial costs on individuals and the economy as a whole. Making the tax code less complex is a worthwhile aim, and should continue to be a congressional priority as tax reform moves forward.
Charles Hughes is a policy analyst at the Manhattan Institute. Follow him on Twitter @CharlesHHughes.
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