U.S. Tax Compliance Costs $44B, not $400B

"There are three kinds of lies: lies, damned lies and statistics." ~ Mark Twain -

According to the Tax Foundation, federal income tax compliance costs were projected to reach $392 billion by 2011, and $483 billion by 2015. Now they say it’s probably in the ballpark of $400 billion as of 2011. So in other words, they figure that it costs taxpayers 20 to 40 percent more than is paid in taxes just to fill out and file the forms. However, what people echoing these numbers overlook is the fact that these figures are based on Internal Revenue Service estimates made during an era in which tax forms were completed with a tax booklet, pencil and calculator, a methodology that even the IRS discontinued in 2006. The fact that the Tax Foundation assigned a dollar value to outmoded time estimates, based on a taxpayer’s average hourly earnings, is even more appalling. The real eye opener ought to be that a huge chunk of the dollar cost mentioned is not money that anyone actually spends. It is rather the value placed on the time each taxpayer would spend preparing their income tax return if (1) they actually prepared their own tax return, (2) they prepared their return with a tax instruction booklet, paper forms, a pencil, and calculator, and (3) they were compensated for their time.

To prove just how bogus this figure is, I pored over the Tax Foundation’s 2005 report. The first thought that occurred to me is that the reason the report hasn’t been updated since then is because the IRS stopped estimating the time it takes to manually fill out tax forms in 2006, and without these estimates, the Tax Foundation’s theoretical foundation disintegrated. And why did the IRS stop making these estimates? Well, primarily because since it began accepting electronically filed returns in 1990, and set a goal of achieving – “80% of all tax and information returns filed electronically by Filing Season 2007", and with the advent of personal computers and cheap software, the amount of time spent and cost of preparing income tax forms has declined dramatically. Thus, the idea of one toiling for 17 to 23 hours, or longer, over a 2 to 3 page tax return is passé.

One section of the report states that: “When examined by income level, compliance cost is found to be highly regressive, taking a larger toll on low-income taxpayers as a percentage of income than high-income taxpayers. On the low end, taxpayers with adjusted gross income (AGI) under $20,000 incur a compliance cost equal to 5.9 percent of income while the compliance cost incurred by taxpayers with AGI over $200,000 amounts to just 0.5 percent of income.” What the Tax Foundation is saying is that a person with $20,000 of adjusted gross income would incur a cost of $1,180, or 5.9% of their income, in preparing their income tax return, and a person making $200,000 would expend $1,000, or 0.5% of their income. Does that match your experience, because it’s complete nonsense from my vantage point? Is this even remotely reasonable? Let’s examine this theory in more detail.

Following the Tax Foundation’s logic, we could assign a cost to virtually everything we do, as a function of our annual income. Never mind the fact that we only get paid for the time we actually work. So in other words, if you make $9.61 per hour on the job, and it takes you 2 hours per week to wash your clothes (on your time off), then according the this theory, the real cost of clothes washing is more than $1,000 per year ($19.22 times 52 weeks; plus washing powder, water, electricity, and depreciation of your washing machine and dryer), or more than 5.0% of your annual income. Carrying this through to its illogical conclusion, for a person who works 8 hours per day, the cost of sleeping 8 hours per night would be equal to their annual income, right? So one can only ponder the cost of watching television, driving to and from work, mowing the yard, etc… You can see how silly this is. To drive the point home, under this theory, if you work 8 hours per day, and have 16 hours of free-time, then the cost of everything you do outside of work would be twice as much as your annual income. In other words, you’re not actually making $20,000 per year, heck, you’re not even breaking even; you’re going in the hole by $20,000 every year. Well, so much for that theory.

I have had the fortune of preparing income tax returns, both in the early 1980’s, before the advent of personal computers, and in the 21st Century with high speed internet and gigabytes of random-access memory. In the early 1980’s it took literally days to complete a complex income tax return. Information would be gathered and written onto data forms in pencil, then shipped off to a main-frame computer processing center. The printed return would then be mailed back in about 3 business days, although a typographical error would easily double this time-frame. Then the taxpayer(s) had to be summoned to come in and sign the return before it could be postmarked. The cost of preparing an itemized Form 1040 with Schedule A, plus a state tax return, back then averaged around $150. Most non-itemized returns were completed on the spot, with pen and calculator, for around $85. What some people miss is that since $150 in 1981 had the same buying power as $380 today, annual inflation over this period being 3.16%, and since the average cost is still around $150 today (in the Southeast), the cost of preparing income tax returns has actually declined by around 61%, over the past 30 years. But you won’t hear about this from today’s rubber stamps.

It was in 1990 that IRS e-file became operational nationwide, and that year 4.2 million returns were filed electronically. I was working for the IRS at the time. Later on, when I started my own practice back in the year 2000, after doing other things for a few years, part of my mission statement read, “To assist the Internal Revenue Service in their goal: ‘To have 80% of all tax and information returns filed electronically by Filing Season 2007’". By the year 2007, as per the table below, the percentage of electronically filed returns had only reached 57%, however, many practices, such as mine, were already near the 100% mark. As a result, ever since then, that part of my mission statement has read, “To file 99.9% of all income tax and information returns electronically”. Nowadays, a tax preparer, who prepares more than 10 returns per year, is required to file all returns electronically.

From personal experience, these days it takes about an hour to prepare and e-file the same income tax return that used to take 3 days or longer. Like in many other industries, technology has made tax compliance both cheaper and more efficient. While prices have risen dramatically in other sectors, such as Education and Health Care, the cost of professional income tax preparation has plummeted, on an inflation adjusted basis. Most notably, the time it takes to prepare a return has been reduced from days to minutes. Similarly, the time it takes to receive an income tax refund has been reduced from 6 to 8 weeks, down to 7 to 10 days. This is precisely why the IRS no longer publishes obsolete manual computation time-frames.

The 2005 1040 Instruction Book, on page 79, states, for example, that the time and cost of preparing a Form 1040 with Schedule A and other schedules, but no Schedule D, was as follows (see table below, 3rd row from the top):

In analyzing this, does anyone out there seriously believe that it would take 6 hours longer to self-prepare a tax return with software, than without? Like that makes sense. And what kind of practice would a professional be running, if it took 12.1 hours to complete each itemized 1040 return? At that pace, a professional would only be able to complete around three 1040 returns per week, and since the regular season only lasts about 12 weeks, would only be able to prepare around 40 returns per season, with a seasonal income of around $6,900. If it really took a professional 12.1 hours to prepare each an every itemized Form 1040, we would indeed have a problem. However, since actual facts and figures reveal that tax preparation really takes a fraction of the time it used to, and costs less than half of what it did 30 years ago, perhaps we don’t have a problem after all, at least not a ‘cost of income tax compliance problem’.

According to Nickel, over at the fivecentnickel.com, his research coming from the National Society of Accountants biennial survey, the average tax preparation fee for an itemized Form 1040 with Schedule A, plus a state tax return, was $229 in 2010. And for a Form 1040 and state return without itemized deductions, the average price was $129. But keep in mind that tax preparation fees vary regionally, so the above averages aren’t necessarily applicable depending on where you live. The lowest costs are in the Eastern South Central region (AL, KY, MS, and TN) where a Form 1040 with a Schedule A and state return averages $137. And the most expensive region is the Pacific (AK, CA, HI, OR, and WA) at $292.

He also found that for those with more complex returns, modern day costs average as follows (again, prices will vary by region):

Here in the Southeast, a professionally prepared itemized Form 1040 with Schedule A, plus a state tax return, takes about an hour to prepare, and the fee averages $150. The question of whether a person making over $200,000 will pay more, or less, is actually not based on their income, but rather on how many forms need to be prepared? So if an itemized Form 1040 with Schedule A, plus a state tax return, costs an average of $150 to prepare, that’s generally how much it costs no matter how great one’s income. That’s because the time it takes to prepare such a return would be about the same. If it costs more, it’s most likely due to additional form filing requirements. Thus, the true modern day cost of $150, to prepare such a return, is a far cry from the Tax Foundation’s estimate of $1,000.

At the same time, a basic 1040-EZ or 1040-A, plus a state return, would take around 30 minutes to prepare, with an average fee of $85 ($60 without the state). This is also a major discrepancy from the Tax Foundation’s estimated cost of $1,180, for a person making $20,000 per year. If we were to follow this artificial tack, then we would have to believe that it would take something in the order of 122.7 hours to prepare a basic 1 to 2 page 1040-EZ or 1040-A return, at a cost of $9.61 per hour (the hourly wage for a person making $20,000 per year). Therefore, the Tax Foundation’s purported $400 billion per year estimate is grossly overstated.

The act of basing an entire tax reform platform on factitious information is called, “fraud”. So who’s been out on the stump quoting these make-believe numbers? Of late, it’s been Mitt Romney, Rick Perry, previously Herman Cain, and a host of others. But it’s time for the public to wake up and realize that the Tax Foundation’s figures are completely bogus. Sure, some returns take longer than others, some cost more than others, and most businesses require monthly or quarterly accounting and payroll tax services on top of income tax return preparation. But what’s the alternative for a business, to not have any record of whether it is profitable? Can businesses just do away with all record keeping and financial reporting for the sake of skimping on an ordinary and necessary business expense? I don’t think that would be a wise move.

To conclude, the Tax Foundation’s estimate is a made-up number, based on obsolete data. The true costs of complying with federal income tax laws have declined dramatically over the past 30 years. Thus, anyone floating figures ranging from $400 billion to $500 billion per year must have their head in the sand. There’s no way you could ever convince me that it takes 122.7 hours, to enter the amounts contained on a W-2 Form into a computer program, or onto a paper form, in order to file a simple 1040-A or 1040-EZ return. Nor can you persuade me to believe that the cost of preparing such a return could ever reach $1,180. But that’s essentially what the Tax Foundation’s report says.

The correct method of determining any cost is to add up the actual outlay in cash, but since the Tax Foundation has not chosen this method, I must conclude that their estimate is overstated by as much as 88.9%. How did I arrive at this percentage? Well since the cost of a simple 1040-A or 1040-EZ, plus a state tax return, is actually $85, not $1,180 as they would have us believe, the Tax Foundation’s estimate is off by 92.8% ($85 vs. $1,180). And since the cost of preparing an itemized Form 1040 with Schedule A, plus a state tax return, is actually $150, instead of $1,000, they are off by 85% ($150 vs. $1,000). Averaging these two percentages together results in an overstatement of 88.9%. Thus, I conclude that the Tax Foundation’s estimate, that federal income tax compliance is costing Americans around $400 billion per year, is in reality probably closer to $44.4 billion (11.1% of $400 billion).

Frankly, I would be more concerned about real and verifiable IRS statistics, such as the number and amount of refunds being doled out. For example, in 2010, out of the 142,449,000 returns that were filed, 109,376,000 received refunds totaling $328.4 billion, for an average refund of $3,003 per return. Now that’s real money, which, if you think about it, is being summarily piled on to the national debt. So what’s up with that?

So if your time is worth $150 an hour, its not worth to make your own sandwich (you save so much going out to eat) much less wash the car or mow the lawn.

You're somewhat correct. When I owned a home, it wasn't worth it for me to mow my lawn or do any yard work. I paid a service to do it. I used to change the oil in my car. Again, it's no longer worth it to me to change it myself.

Making a sandwich? It depends. Only takes me a few moments if I want one. If I want a complicated sandwich, for instance an Italian beef sandwich with peppers on a home baked Italian roll, you bet I go out for it. It's not worth the time it would take me to make the beef or bake the bread. It's the same with BBQ. I used to smoke my own brisket. Now I am willing to go to Oklahoma Joes for their award winning brisket.

Personally I use a cost/benefit analysis to decide whether it's worth it for me to do something. And yes, I consider my time worth something, including my "resting" time, which especially now that I've been near death and bed ridden and on IV antibiotics for a month in the hospital , and in the hospital for another month past that, managing to survive 9 surgeries, you bet I count every minute of my time.

Mark

Unless you actually had to take unpaid time off from work for tax compliance, there's no way in my mind you can justify a fictitious expense.

That's utterly preposterous. What about unpaid time after work? In your mind, my time has no value unless I am "at work" drawing a paycheck? If it takes someone many hours to gather paperwork to do their personal 1040, you assume that to be worthless time because they don't do it between 8 and 5? No wonder you get a cost of compliance that's 11% of what it really costs. You (and your friends at the Tax Court) deliberately ignore the unpaid efforts of millions of taxpayers.

2/3 of my life, and every other life, has no value to you. The rest of our entire existences must seem like one great big fictitious expense to you.

Also, the Tax Foundation's analysis is not based on money actually spent. That's the biggest flaw in their report. My point is you can't assign a cost to things that are free of charge. Otherwise, you just cost me about $125 for this reply.

Let me chime in with practically everyone else here on the thread: Your claim that you can't assign a cost to things that are allegedly "free of charge" is preposterous. Worse than that, it is simply invalid.

Besides my regular 35-hr-a-week job, I earn €60/hr in my "leisure time" doing freelance work. It's good work - if you can get. Now, I don't have an unlimited supply of such freelance work - but if I did, I'd probably pay someone to remove the weekly build-up of lint from my navel, since it'd be cheaper than my doing it myself.

But all the same, perhaps a better analogy would be: If you can't assign a cost to it, then I suppose that you wouldn't mind spending FIVE TIMES as much time archiving receipts, trying to understand gov't booklets, and filling out forms in order to pay your income tax, would you? After all, your time "costs nothing," i.e., has no value, right?

Are you even a Conservative?

Regards,

A business would incur the same costs of record-keeping even if there were no income taxes, otherwise it would be flying blind and have no idea whether it was profitable or non-profitable, and thus no accountability to its owner(s). The actual costs of record-keeping have declined, just like income tax preparation, due to technological advances.

This guy never even ran a lemonade stand. First, every small business owner has a bank account, and so you know whether your bank balance (adjusted for money the owner takes out as "salary" is going up on a weekly, monthly or yearly basis (which is called a profit) or down (which is called a loss). A small business owner knows whether individual transactions are profitable or not. A small business owner also understands his costs (rent, lighting, supplies,etc.) and watches these carefully.

Part of this guy's problem is that the time spent filling in the blanks and adding up the columns of numbers is trivial grade school arithmetic. What takes all the time is figuring out the numbers that go in the blanks on a schedule "C." If all I had to do was write down my income, take a home mortgage and local tax deduction as well as deductions for dependants, add the numbers up and look up my tax in a tax table, and then calculate my refund that would be a 1/2 hr exercise every year. In fact it would take longer to use a computer because I need to figure out how to use the program, rather than addition and subtraction, which, gain, I learned in grade school.

Did this guy graduate from kindergarten even?

What's up with that is that more money was deducted from their income than was actually owed in tax, and therefore the balance is owed to the taxpayer. Every clueless twit out there who has ever worked and filed even a 1040EZ knows THAT, everyone except this clueless twit.

My point is you can't assign a cost to things that are free of charge. Otherwise, you just cost me about $125 for this reply.

This sentence makes zero sense economically. By definition, leisure time is MORE valuable than time spent

We have a finite amount of time in which to sell our labor to an employer or attempt to generate income through self-employment. When we make the decision to forgo the additional income we would receive from working one additional hour, we are saying that we value not-working more than the lost opportunity cost. Consequently, it is entirely reasonable to value lost time spent on taxes at the individual's / business's lost opportunity costs from working an additional hour at their job. By refusing to put a dollar value on non-working time, you're skewing the analysis in favor of a conclusion that radically undervalues mandatory service to government needs.

>>...received refunds totaling $328.4 billion, for an average refund of $3,003 per return. Now that’s real money, which, if you think about it, is being summarily piled on to the national debt. So what’s up with that?...<<

I think you might be confusing “refund” with “revenue loss” when in actuality it is often the return of an interest-free loan the taxpayers gave the govt to protect themselves from under-paying.

Here is the biggest outrage: You are tasked with complying with a tax code resembling an impossible Gordian-knot. This impenetrable tax-code *FORCES* you under threat of prosecution to affix your legal signature to a tax-return swearing your full compliance. GOD help you if you ever make the smallest of unintentional mistakes and your tax return catches the eye of some IRS thug who is having a bad day and looking for someone to take out their frustrations on. Even if the matter is ultimately settled fully in your favor, you will be out time, lawyer fees and sleepless nights thanks to some “D” student IRS flunky who enjoys union protection to go terrorize some other taxpayer who failed to understand or unravel that Gordian-knot to the thug’s satisfaction.

This is the sword/system we voluntarily live under. And we continue to elect legislators who refuse to do anything about it. So, in that regard, we only have ourselves to blame.

Bleh... Don’t get me started...

“What’s up with that is that more money was deducted from their income than was actually owed in tax, and therefore the balance is owed to the taxpayer.”

Really? Why you’re such a genius. I guess you never heard of refundable tax credits: the child tax credit, earned income credit, and making work pay credit were a huge chunk of this amount. The refundable portion of these credits, represent refunds of money not paid in and refunded back, but rather amounts over and above any taxes paid. That’s why 40% of those who file income tax returns don’t pay any income taxes. So why do they bother to file? They’re not filing to get back money that they previously paid, they’re filing to receive a welfare benefit tax expenditure.

The facts are already out there, I have no desire to repeat them in every post I write. It’s up to you to bring yourself up to speed.

You should study some elementary economics. In fact, if you chose to reply to my post instead of do something which you would be compensated for, then the post did cost you what you could have earned elsewhere. Now in the case of the posting, you chose to not earn the money. The same can't be said for the time spent filing a tax return, or keeping the records needed to support the filing.

The concept of opportunity cost is used to measure the cost of alternate uses of resources, including one's time. And yes, if your post took 1/2 hour and your normally earn $250 per hour than your choice to write the post cost you $125.

Not really. There is a tremendous difference between the accounting used for operational purposes and the record keeping and accounting used for tax purposes. That's why an 1120 has a whole section where the corporation sets forth the differences between book income and taxable income, for example.

I encourage you to read just the section of the tax code that deals with fixed asset depreciation and tell me if that level of complexity would be required for the owners of a business to know if they were profitable or not.

The actual costs of record keeping have not declined appreciably, although the productivity of accounting professionals has jumped dramatically due to the use of computers. I suspect this is due to the increasing complexity of the records required to support the various regulations imposed on businesses.

Do your really believe the Tax Foundations numbers saying we spend about half as much money preparing income taxes as we make in payments?

Sorry, but I'm not buying. Its nowhere near true for me.

The time estimates for various types of tax returns listed by the Tax Foundation which are the basis for their estimates seem reasonable. For example, they estimate at total time of 3.8 hours and an estimated total cost of $152 for a person filing a 1040ez which doesn't seem unreasonable. The cheapest online HR Block price I found was $129, and you still need to spend the time interacting with their system.

The Tax Foundation seems to use an hourly opportunity cost of $40 per hour, which may be more than you value your own time at. But many people value their own time at close to that amount or more when they choose how to spend their money. (If that wasn't true than no one would pay HR Block to do their taxes.}

I sampled two types of returns and found the cost estimates grossly overstated. For a person with $20,000 of income and one W-2 Form, who does not itemize deductions, the Tax Foundation says they will incur tax compliance costs of $1,180, or 5.9% of their income. So how much time and effort does it take to store a W-2 form and then enter it on a one page tax form, or take it to a tax preparer? I say no more than $85, but it might not even cost that much for a self-prepared return.

You should re-read the report from the Tax Foundation. In particular look at Table 4. The report lists the time for each of the tax returns likely to be filed by an individual, including those likely to be filed by an individual with $20,000 in income. For a 1040EZ, for example, they estimate 3.8 hours for a cost of $152, which is only slightly more than what HR Block charges for a simple return.

As I noted originally, your analysis is based on a faulty understanding of the report itself, along with erroneous logic.

If you want to get a quick look at one element of compliance costs for simple situations you can use the HR Block online tax return cost estimator. Given their success in the market their prices are a useful indicator of the costs incurred, apart from record collection before interaction with their system. Try some different kinds of returns.

"You should re-read the report from the Tax Foundation. In particular look at Table 4. The report lists the time for each of the tax returns likely to be filed by an individual, including those likely to be filed by an individual with $20,000 in income. For a 1040EZ, for example, they estimate 3.8 hours for a cost of $152, which is only slightly more than what HR Block charges for a simple return."

Perhaps I should not have combined the 1040A and 1040EZ forms together, but the reason I did is because the Tax Foundation stated that, "costs are regressive at 5.8% of income for a person making less than $20,000", which I find to be ridiculous.

If you look at the report and Table 4 again, you will see that it represents totals for the year 2004. If you then compare the 2004 total to their 2011 projection, you will note that the 2011 estimate is 61% higher than the 2004 amounts, which are shown in the other Tables. Since I am talking about their $400 billion estimate for 2011, you must multiply everything on those tables by 161% to be on par. Did I not mention that the report hasn't been updated since then, because its basically obsolete?

Then if you take the 13.6 hours for a 1040, plus the 5.6 hours for a Schedule A you will arrive at a 2004 cost of $752, which equals $1,210 at the 2011 rate.

If you then take the 15.5 hours to complete a 1040-A return, you will arrive at a 2004 cost of $607, which equals $978 at the 2011 rate. [Note: A 1040-EZ would cost $240 at the 2011 rate, but I admit, I combined it with the 1040-A, for the reason mentioned above.]

So my report is right in the ballpark. The Tax Foundation's projections are overstated by more than 88.9%. The fact that I used their own percentage of income method against them may change the semantics, but it doesn't change the end result.

[PS: I don't need H&R Block to tell me how much tax returns cost. Did I not mention that I've been in and around the industry for nearly 30 years?]

Now excuse me, I have to download a year's worth of bank transactions into Excel, which should take about 10 seconds. Then I have to print out copies of my canceled checks.... Oh, I forgot, I don't write checks anymore. What used to take days now takes minutes, for me anyway, I don't know about everyone else.

If you look at the report and Table 4 again, you will see that it represents totals for the year 2004. If you then compare the 2004 total to their 2011 projection, you will note that the 2011 estimate is 61% higher than the 2004 amounts, which are shown in the other Tables. Since I am talking about their $400 billion estimate for 2011, you must multiply everything on those tables by 161% to be on par. Did I not mention that the report hasn't been updated since then, because its basically obsolete?

Did you ever consider that perhaps the 2011 estimate includes an increase in the number of returns? Scaling the cost per return by the increase in total cost is only logical if the number of returns remains constant. But the number of filed returns in 2011 is unlikely to be equal to the number filed in 2004. So your analysis is flawed.

Moreover, you don't seem to understand that compliance costs are independent of the amount of tax due, so it is very possible for the compliance cost for a filer is equal to or exceeds the amount of tax due by a large margin. This makes your percentage based analysis pointless and illogical.

For example, consider a FUTA return for one employee where all state unemployment was paid. If you are experienced in the business you know what the tax is. Can a customer hire you to file a 940 and four quarterly state UI returns for less than $100? I doubt it. Oh, and for the same $100 (actually $56 if my memory is working well) can you do the payroll record keeping too?

From a percentage point of view what is the percentage for a filing where no tax is due? Pretty large, right? Lets take a zero liability 1120. What percent of $0.00 is say $3500?

You may have filled in a lot of tax forms, but your estimates of tax compliance costs are unlikely to be correct based on the methods you are apparently using for your analysis. Your estimate is also inconsistent with even a quick estimate based on published industry information.

About 129 million individual tax returns are filed.

A typical cost paid by a taxpayer for a personal return is about $185. This is a rough indication of the market price, or the point where consumers decide their own expense would be greater than the service supplier's price.

This rough estimate of just personal return filing costs - not recordkeeping, or time spent going to and from the tax preparer, etc. yields a cost of $24 billion. And we haven't even touched on all the accounting and filing costs related to business taxes, employment taxes, etc.

Under your model of the industry the total cost of all business tax preparation, accounting, and related legal services, and hence the income to everyone in the country working in those industries is around $16 billion. That means that the 1,762,000 accountants in the country have an average yearly salary of about $9000. Do you think that is even close to true? Or are they more likely to make ten times as much?

“90% of an accountant’s day is tax compliance.”

Really? In my corporate accounting days, 90% of my time was spent making sure nobody was stealing parts and supplies through taking sometimes daily inventories, running credit checks on customers, billing customers electronically, collecting bad debts, making sure bills were paid on time, preparing reports for SEC compliance, preparing reports for management and shareholders, handling acquisitions, and preparing reports for credit purposes. The tax department was always the smallest part of the group, usually factored out, and of the least concern.

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