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Tax Simplification, Compliance Costs and Deadweight Loss

By February 13, 2008

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Aaron Schiff at 26econ.com writes:
Freakonomist Steven Levitt is excited about a plan by Austan Goolsbee to eliminate tax returns for people with relatively simple tax situations (eg receiving income from only one employer). A massive amount of paperwork would be eliminated, saving real costs of $44 billion.

I’m a little surprised the US is so slow catching on to this idea. This system has been employed in New Zealand for several years and it seems to work pretty well.
What caught my eye in Levitt's piece was this:
By Goolsbee’s estimates, as many as 40 percent of all Americans could be covered by the Simple Return. He reckons this could save 225 million hours of tax preparation time per year and $2 billion in spending on tax preparers.
Economists spend a lot of time discussing the deadweight loss from high marginal taxes - Greg Mankiw has a terrific piece on the issue here. But I wonder if we're barking up the wrong tree. The deadweight loss from compliance and enforcement costs of a complicated tax code are massive as well, but this topic is largely only discussed by economists working for think-tanks. I suspect we would be better served in working on making the tax code far less complicated rather than simply lower.

Obviously some groups would lose a great deal of their cherished deductions were taken away. However, Canada's Andrew Coyne believes overall a revenue-neutral tax simplification plan - where deductions and complications were eliminated, but marginal rates lowered, would be a political winner:
At some point in the not too distant future, one or another of this country's party leaders is going to campaign for office waving . . . a postcard. "This," he or she will proclaim, "is what your tax return will look like under my tax plan. As you can see, it's only got 10 lines on it. You can fill it out in about five minutes. No receipts to keep, no complicated forms to fill out, no need to hire an accountant. And the rate? Just 15 per cent."

That candidate, I predict, will be swept to power. It won't even be close. Tax reform bores like me tend to drone on about incentives and revenue neutrality and marginal rates of snzzzzz. But what will light a fire under the average taxpayer, even more than the promise of lower rates, is that postcard.
I'm not sure if I agree with Andrew - because deductions, some of which are only used by a select few, are being removed, the people who gain from such a change have relatively modest gains relative to the people who lose. Recall what the Logic of Collective Action has to say about those situations.

Comments

February 13, 2008 at 10:46 pm
(1) Anthony says:

Giuliani had a simplified tax system. The first line? “Income from All Sources”. So, basically, instead of giving people a Schedule C to calculate their business income and a Schedule E to calculate rental income and a 4562 to calculate depreciation, etc., he just bunched it all together and put it on one line. I guess you’re supposed to calculate all this on napkins which you can then keep for your records in case you get audited. How would the government choose who to audit anyway? The guy who makes $100 babysitting and has no expenses would report the exact same numbers as the woman who collects $1 million in rent, has $100K in depreciation, and $1,799,800 in business meals.

Sure, you can eliminate many of the deductions and credits and phaseouts and simplify things a great bit, but the postcard thing will never work unless it’s limited to the types of people who can already file a 1040-EZ. “Income from All Sources” simply does not have a simple universally agreed upon definition.

February 14, 2008 at 1:09 am
(2) Gabriel says:

If the logic of collective action applies than for us to talk about what government *should* do is naive, no?

February 14, 2008 at 5:11 am
(3) Jon says:

As long as companies like H&R Block are bringing in big money just figuring out which numbers people should put in which spaces on which forms, the tax code is pretty obviously diverting resources into obscenely suboptimal directions.

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