Estimates of compliance costs are  uncertain because taxpayers generally do not keep relevant records  documenting their time and money spent complying with the tax system  and many important elements of the costs are difficult to measure because,  among other things, federal tax requirements often overlap with  recordkeeping and reporting that taxpayers do for other purposes. Consequently, if one wishes to define the compliance costs  attributable to the federal tax system as only those costs that would not  exist in the absence of that system, then one needs to assume what the  requirements of state and local tax systems, as well as those of financial  accounting systems, would look like in the absence of the current federal  tax system and make sure that none of the costs of complying with those  requirements are included in the estimate of federal compliance cost. Studies we found that focus on the compliance costs of businesses  estimate them to be between about $40 billion and $85 billion per year. The Extent to Which Compliance Costs Could be Reduced Depends Upon the Details of a Redesigned Tax System

The estimates presented above do not represent the potential cost savings  to be gained by replacing the current federal tax system. Efficiency Costs Arising from Tax- Induced Changes in Behavior Are Likely to Be Large but Can Only Be Modeled with Considerable Uncertainty

Economic efficiency costs occur when tax rules cause individuals to  change their work, savings, consumption, and investment behavior in ways  that ultimately leave them with a combination of consumption and leisure  (now and in the future) that they value less than the combination they  would have obtained under a tax system that did not distort their behavior. Estimating efficiency costs is very challenging because the tax system has  such extensive and diverse effects on behavior. However, the  efficiency cost of the current tax system may not fall within that range  because of uncertainty surrounding taxpayer’s behavioral responses to tax  rules, changes in the tax code and the economy since the mid-1990s, and  the studies do not cover all of the sources of efficiency costs. Estimates of Efficiency Costs Are Highly Uncertain Because the Tax System Has Such Extensive and Diverse Effects on Behavior

Estimating the efficiency costs of the federal tax system is an enormous,  complicated, and uncertain task, given the complexity of existing tax rules,  the breadth and diversity of the U.S. economy and population, and the  limited empirical evidence available regarding how individuals and  businesses change their behavior in response to tax rules. While No Comprehensive Estimates of the Tax System’s Efficiency Costs Exist, Available Partial Estimates Suggest Those Costs Are Large

None of the studies we reviewed provides a comprehensive estimate of the  efficiency cost of the U.S. federal tax system since the tax reform of 1986. The more  comprehensive studies we found show costs on the order of 2 to 5 percent  of GDP each year (as of the mid-1990s). Applying this percentage to federal corporate and  personal income tax collections in 1997 would yield efficiency costs of  about $200 billion or, roughly, 2.5 percent of GDP in that year. These changes could have decreased the efficiency cost for  individuals. 1. GAO. GAO.
Why GAO Did This Study

In 2005, Americans will pay about $2.1 trillion in combined federal taxes, including income, payroll, and excise taxes, or about 16.8 percent of Gross Domestic Product (GDP). However, the amount of taxes paid does not reflect the total cost to taxpayers of the federal tax system. In addition to taxes paid, taxpayers also bear compliance costs and efficiency costs. Understanding the magnitude of these additional costs is important because every dollar spent on compliance and lost due to inefficiency represents a dollar that society could have spent for other purposes. In response to a congressional request for information on the magnitude of the compliance and efficiency costs of the current federal tax system, this study describes the nature of these costs, presents the difficulties associated with estimating them, and summarizes existing estimates of their magnitude. GAO did not make independent estimates of compliance or efficiency costs nor did we replicate any of the studies. GAO is not making any recommendations in this report.

What GAO Found

Complying with the federal tax system costs taxpayers time and money. Estimating total compliance costs is difficult because neither the government nor taxpayers maintain regular accounts of these costs and federal tax requirements often overlap with recordkeeping and reporting that taxpayers do for other purposes. Although available estimates are uncertain, taken together, they suggest that total compliance costs are large. For example, combining the lowest available estimates for the personal and corporate income tax yields a total of $107 billion (roughly 1 percent of GDP) per year. As noted, whether this is a definitive lower bound for compliance costs is uncertain. The tax system also results in economic efficiency costs because tax rules cause individuals to change their behavior in ways that ultimately leave them with lower-valued combinations of consumption and leisure than they would have obtained if the tax system did not affect their behavior. Estimating efficiency costs is very challenging because the tax system has such extensive and diverse effects on behavior. In fact, we found no comprehensive estimates of the efficiency costs of the current federal tax system. The two most comprehensive studies we found suggest that these costs are large--on the order of magnitude of 2 to 5 percent of GDP each year (as of the mid-1990s). However, the actual efficiency costs of the current tax system may not fall within this range because of uncertainty surrounding taxpayers' behavioral responses, changes in the tax code and the economy since the mid-1990s, and the fact that the two studies did not cover the full scope of efficiency costs. The goal of tax policy is not to eliminate compliance and efficiency costs. The goal of tax policy is to design a tax system that produces the desired amount of revenue and balances the minimization of these costs with other objectives, such as equity, transparency, and administrability. In addition, whether compliance and efficiency costs could be reduced by redesigning the tax system and, if so, by how much would depend critically upon the detailed characteristics of the new tax system.