The Role of Administrative Factors in Tax Reform: Simplicity, Compliance and Enforcement

Abstract

This paper examines the role of administrative factors in tax reform. How difficult is it for taxpayers to comply with and understand the current tax system? How much does operating the system cost? How well are taxes enforced? How would modifying the income tax or starting over with a new system affect the answers? The answers to these questions, and the trade-offs and interactions between simplicity and other policy goals are crucial elements of tax policy choices. We show that there are significant disagreements concerning the operating costs and complexity of the current income tax system and that outdated, incomplete, and poorly conceived data on compliance costs contribute to the range of estimates. Based on the available data, we find that the current system imposes compliance and administrative costs of between $75 billion and $130 billion per year on individuals, businesses, and the federal government. We discuss several ways to improve the administration of the existing tax system and reduce compliance costs. We also show that pure versions of the national retail sales tax and the flat tax could dramatically reduce filing burdens for millions of taxpayers. However, realistic, politically plausible versions of both the sales tax and the flat tax would require tax rates much higher than those advertised by their proponents. These higher rates complicate tax compliance and enforcement. The sales tax would face potentially serious problems with enforceability and political pressure for exemptions. The flat tax would face the same political pressures, and while enforceability is not a major concern, the tax would likely become significantly more complex than currently proposed. Thus, there is considerable potential to simplify the tax system. Policy makers and voters should analyze this potential in the context of the trade-offs it creates with other goals of tax policy-including efficiency, fairness, revenue, and privacy.