If you have the fortitude to read this and get an appreciation (not necessarily a full understanding) of why the U.S. tax system’s marginal excess burden (MEB) is important, you deserve a gold star and will also have learned why economics is called “the dismal science.”
This, however, is as important an issue as business managers will face in the coming year because America is awash in tax uncertainties. Many of the ideas here are based on work done by Christopher Conover, a research scholar at Duke University, and he must be commended for coalescing these economic concepts and revealing them for our insight.
Overall burdens of taxation are much larger than tax receipts because taxes distort behavior of individuals and businesses. It is quite evident that costs of taxation include administrative expenses incurred by government(s) to devise, administer and enforce tax laws. Federal expenses run a bit over 0.5% of receipts. Compliance costs cover the value of record keeping, accounting and legal fees by the private sector and amount to about 9.4% of federal tax receipts (and an added, undefined amount for similar performances at the state and local level).
In addition to obvious administrative and compliance expenses is the excess hidden-cost burden wrought by changes in personal and business behavior due to taxation. Economists agree that increasing marginal tax rates on labor income decreases taxable income to government. For example, it is more beneficial for a worker to get non-taxable fringe benefits than taxable income or to make purchases with outcomes to avoid tax, such as buying a residence instead or renting one and reducing taxable income with mortgage interest and property tax deductions under current tax law.
Other examples of MEB distortions are in capital taxation on personal savings and investments that are taxed multiple times. Taxation of dividends as profit at a corporate level, and again as dividend income to individuals, diverts funds into less-performing assets such as real estate or foreign equities. Further, deductibility of interest payments but not dividends induces U.S. businesses to finance investments through more debt instead of equity, which slows and distorts investment reallocations.
Skewing tax and investment behavior also encourages seeking tax havens and establishing offshore industry in more favorable and tax-friendly environments. Economists agree that federal tax MEB ranges from 14-52% of revenues, averaging 44% of all federal taxes. (This entire subject is silent on an equivalent kind of inefficiency caused by subsidies that are actually taxes with negative rates. But that’s a topic for another day.)
These results are agreed upon by both the House Joint Economic Committee (report #110-8) and the Conover study. However, the popularized notion is that Americans only pay 18% of GDP in federal tax. In truth, the true cost to taxpayers is more likely 27% of GDP.
The conventional way and that which is politically expedient for measuring excess burden is to compare it to the amount of tax revenue raised. The better way is to examine the marginal or additional deadweight loss connoted by MEB instead of the understated comparison. The fact that this is a subject for discussion here indicates that (I believe) the political establishment has intentionally obfuscated accounting accuracy. May I suggest to readers that this is a fine topic to ask the new Congress to resolve.
Congress should not commit scarce tax resources to any initiatives until Members making the tax laws have a full accounting of the costs and benefits of what is to be authorized. This means that Congress must direct the Joint Committee on Taxation and the Congressional Budget Office to incorporate these MEB costs into budget analyses and base passage of legislation on whether benefits equal or exceed the total cost.
With over $107 trillion in unfunded liabilities for Social Security and Medicare, in its existing form and without consideration of additions of the PPACA (Obama Care), Americans cannot afford to not consider the full and accurate cost of government. As Conover indicates, “It is irresponsible for Members of Congress and the President to spend taxpayers’ earnings without understanding the full burden they are imposing on those taxpayers.”IH