The Rising Cost of Complying with the Federal Income Tax
In a recent report published by the Tax Foundation, the estimated tax compliance burden due to the federal income tax was $265.1 billion in 2005. Mainer’s share of the compliance burden is $1.26 billion. This represents a whopping 29.7 percent of all federal income taxes collected in Maine–34 percent higher than the national average of 22.2 percent and the 15th highest percentage in the nation. More specifically, Maine individuals represent 44 percent ($558 million) of the tax compliance burden, businesses represent 52 percent ($650 million) and non-profits represent the remaining 4 percent ($47 million).
What are Tax Compliance Costs
Tax compliance can be broken down into three activities: tax planning, audits and litigation and compliance. Tax Planning is what we all do when we try to reduce our tax liability–should I buy a house to reduce my taxes, give to the church, etc. Tax audits and litigations occur when the IRS does not agree with our tax planning and disputes various aspects of one’s tax form. Tax compliance includes the routine administrative tasks such as record keeping, education, form preparation and packaging/sending as the IRS defines it. Out of these three costs, the Tax Foundation report only quantifies tax compliance costs for individuals and businesses. In addition, this does not take into account the time and money Mainer’s spend complying with the Maine income tax system or other types of taxes such as the sales or property tax. So consider this a very, very conservative estimate of the full tax compliance burden on the economy.
The Tax Compliance Burden is Regressive
Ironically, the federal and most state income taxes are designed to be progressive (burden hits high income taxpayers); yet, the tax compliance burden is regressive (burden hits low income taxpayers). A taxpayer with less than $20,000 in Adjusted Gross Income (AGI) would have a tax compliance burden of 5.87 percent. On the other end of the spectrum, A taxpayer with more than $200,000 in Adjusted Gross Income (AGI) would have a tax compliance burden of 0.45 percent.
No Tax Liability Does Not Mean No Tax Compliance Burden
The Tax Foundation estimates that 43.4 million taxpayer (32 percent) will have no federal income tax liability. In Maine, 183 thousand taxpayers (29 percent) will have no federal income tax liability. But they will still have a tax compliance burden as they still must file a tax return just to learn that they have no tax liability! At the very least these taxpayers will be required to file the relatively “simple” 1040EZ form. However, the IRS estimates that it still will take an average of 3.8 hours to file a 1040EZ. Many of these taxpayers will also receive the Earned Income Tax Credit–taking another 0.6 hours.
Non-profits are another group that does not pay income taxes yet faces a large tax compliance burden. Non-profits must, on a yearly basis, file a number of tax forms proving that they have met all the parameters required to be a non-profit and exempt from taxation. This is no easy task. The 990 form required to be filed by a non-profit is estimated to take 135.7 hours to complete. The so-called 990-EZ takes 55.7 hours.
In my earlier post on tax reform, “simplicity” was one of the principles of a good tax system. The federal income tax fails that principal as well as many state income tax systems, including Maine’s. Tax reform would sweep away the tax provisions most responsible for tax complexity such as exemptions, allowances and credits that plagues the current tax code. Simplifying Maine’s tax code would free Maine’s taxpayers, both individuals and businesses, from a huge burden and allow them to spend more time with family or growing Maine’s economy.