merged

The complexity of the tax law also causes the compliance cost of the tax to be high. According to
the IRS, taxpayers spend over 6 billion hours annually keeping records and filling out forms
required to comply with the tax law. They also pay billions of dollars for professional tax help. The
Tax Foundation estimates the compliance cost of the federal personal income tax and the
corporate income tax at more than twenty percent of the tax revenue collected.
The federal personal income tax also imposes a large deadweight loss. The tax appears to be
broad-based, with its general rules that all income is subject to tax and that no expense is
deductible. However, the tax base is made narrower by the presence of numerous loopholes.
Loopholes – exclusions and exemptions from income, deductible expenses, and tax credits.
The presence of loopholes distorts the decisions made in private markets. Taxpayers will alter
their behavior to generate income and expenses that receive favorable tax treatment and to avoid
income and expenses that receive unfavorable tax treatment. Many of the loopholes are large.
The table in Example 14 below lists some of the larger loopholes for the tax year 2015, and the
estimated amount of taxes avoided by each loophole. The information is from the Office of
Management and Budget.
Example 14:
Loophole
Exclusion of employer provided medical insurance
Exclusion of pension contributions and earnings
Deduction of state and local income and property taxes
Deduction of home mortgage interest
Deduction of charitable contributions
Capital gains exclusion on home sales
Exclusion of interest on municipal bonds
Taxes Avoided
$207 billion
148 billion
83 billion
74 billion
57 billion
57 billion
35 billion
Collectively, the loopholes reduce the tax base (personal income) by around 50 percent. This
means that higher tax rates must be imposed to collect the same amount of tax revenue that
could be collected with lower tax rates and a broader tax base. The loopholes are also a big
factor in making the tax complicated.
What Would Make the Federal Personal Income Tax a Better Tax?
A good (economically efficient) tax is one which imposes as little excess burden as possible. The
federal personal income tax imposes a large excess burden. To make the federal personal
income tax a better tax, the excess burden it imposes would need to be reduced. How can that be
done?
Make the federal personal income tax simpler. Eliminate most (or all) of the loopholes. This would
reduce the collection cost and the compliance cost dramatically. IRS agents and tax accountants
could be retrained to do something productive. Taxpayers could spend minutes on their tax
returns instead of hours. Eliminating the loopholes would stop the distortion of private market
decisions currently caused by the loopholes. Eliminating the loopholes would also broaden the
tax base, allowing the same amount of tax revenue to be collected with lower tax rates.
What about the tax rate structure? Would the federal personal income tax be a better tax if it were
more progressive or less progressive? This question involves a trade-off. Making the tax more
progressive would help in achieving the goal of equalizing the distribution of income. Increasing
income equality might increase the consumer satisfaction produced from the limited resources
(see Chapter 31). Making the tax less progressive would help in achieving the goal of minimizing
the deadweight loss imposed by the tax. The best choice for the rate structure depends on the
relative value assigned to each goal.
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13 - 7 Taxes, Deficits, and the National Debt