Simplification of the U.S. Tax Code: A Growth Opportunity
By Eric Tawney '14 (Harris School of Public Policy) | october, 2013, Issue 1
Eric Tawney is a Master of Public Policy Candidate '14 at the Harris School of Public Policy. His academic concentration is in economic policy and public finance. His recent experiences include positions in policy strategy at the Office of Governor Rick Snyder of Michigan and investment analysis at BlackRock. He is a Labor and Finance contributor to the Chicago Policy Review.
Business and politics went head to head in the spring of 2013 as Apple CEO Tim Cook testified before the Senate's Permanent Subcommittee on Investigations. The issue: Apple's tax strategies. With an effective tax rate of just 14 percent, Apple has become the poster child for US tax reform as the Committee, led by Chairman Carl Levin (D-MI) and Ranking Member John McCain (R-AZ), argue that Apple is "gaming the system" through the exploitation of tax loopholes and offshore subsidiaries. Apple, which paid almost $6 billion in taxes in 2012, is accused of avoiding paying an additional $9 billion last year alone. Mr. Cook defended Apple, underscoring the company's large contribution in taxes, and outlined issues that he hopes to see addressed. The final thought offered by Apple CEO Tim Cook was to "pass legislation that dramatically simplifies the U.S. corporate tax system."
In a study by the Laffer Center for Supply-Side Economics titled "The Economic Burden Caused by Tax Code Complexity," authors Arthur B. Laffer, Wayne H. Winegarden and John Childs outline the true costs that the current tax code has on the U.S. economy. The cost of complexity expands across businesses and individuals alike and is bearing a significant burden on the country. The authors estimate that the cost to comply with and administer the U.S. tax system totals $431.1 billion dollars annually, or 30 percent of total income taxes collected. From 2000 to 2010, there were 4,428 tax changes made. From 2001 to 2010, the tax code increased from 1.4 million words to 3.8 million words. These rapid increases in complexity have resulted in individuals spending 3.16 billion hours and businesses spending 2.94 billion hours complying with the income tax code, requiring the equivalent of 3 million full-time workers. Referencing 2009 employment data, the tax industry employs more workers than all of Wal-Mart Stores, United Parcel Service, McDonald's, International Business Machines and Citigroup combined.
In the global race for factories, jobs, innovations and headquarters, economic attractiveness is, or should be, a top priority for policymakers. The authors highlight the important role that tax policy plays in a business' resources as it has a direct effect on income, profitability and return on investment. Capital that could be spent on research and investment has to instead being redirected to "armies" of accountants and attorneys to comply with and optimize taxes against an already high U.S. corporate tax rate in comparison to the rest of the developed world. This cost of compliance puts the U.S. at a disadvantage to attracting important and needed investments. As a result of the current tax code, businesses and individuals spend billions of dollars per year on products and services such as tax software and accounting and legal professionals to help determine tax liability, resulting in deadweight loss for the economy.
In addition to direct costs, behavioral changes that misallocate resources from their most economically-efficient uses towards tax-efficient uses cost the economy a large amount of productivity and GDP growth. Drawing on IRS data collected by the Tax Foundation, the authors estimate that halving the current estimated compliance cost of $431.1 billion would increase total annual economic growth between 0.45 percent and 0.52 percent. Between 1950 and 2009, the compound annual growth rate of real GDP was 3.2 percent. If the tax burden were cut in half, the historical average annual growth rate of 3.2 percent would increase to between 3.65 percent and 3.72 percent. Over 10 years, this would result in approximately $870 billion to $1.0 trillion worth of additional GDP, increasing wealth per person by approximately $2,800 to $3,300 in the 10th year following 50 percent tax simplification. The authors argue that the impact of tax simplification would have a similar economic effect as a stimulus package. However, unlike stimulus packages of the past, this one would occur on an annual basis without reducing any government revenues or requiring any new government spending.
The debates will surely continue between CEOs and politicians over the decisions being made to navigate and reform the tax system. As the U.S. continues to climb out of the worst economic downturn since the Great Depression, reducing tax complexity should be a top priority to increase efficiency and productivity into the economy and raise living standards. In a time of intense global competition, doing nothing is not an option.