Download School of Taxation and Business Law (ATAX)

Australian School of Business
UNSW Business School
MEASURING THE COSTS OF
TAX COMPLEXITY:
AN ECONOMIC PERSPECTIVE
BINH TRAN-NAM, UNSW Business School
Paper prepared for a Tax Complexity Conference
organised by Monash University and UNSW Australia,
Prato, 30 September 2014.
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PLAN OF PAPER
1.Introduction
2.Relative Neglect of Tax Simplicity/Complexity
3.Review of Tax Complexity
4.Costs of Tax Complexity
A simple model of tax compliance
Direct costs
Indirect costs
Macroeconomic costs
5. Summary Conclusion
1. Introduction
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•Importance of taxation
•Role of taxation (Musgrave 1959): allocative, stabilising,
redistributive
•Importance of good tax policy
•Tax simplicity as a criterion of good tax policy: early
theoretical recognition and repeated calls for tax
simplification in the past 30 years
•Tax systems in developed countries are complex
1. Introduction (contd.)
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•Motivation: First step to tax simplification is measuring and
monitoring the adverse effects of tax complexity but the
present applied literature focuses on tax operating costs (i.e.,
direct costs of tax complexity) only.
•Aim: Explore different costs of tax complexity and their
relationships (if any) in a systematic fashion.
•Scope: Focusing on costs arising from tax compliance, and
disregarding costs arising from tax lobbying, evasion,
avoidance, and from interaction between tax complexity and
equity.
2. Neglect of Tax Complexity
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•Explicit recognition: Adam Smith’s cannons of good tax
policy (Certainty, Convenience and Economy).
•Neglected by 19th century classical eocnomists.
•First empirical study of tax compliance costs 80 years ago
(Haig 1935)
•Until the mid 1950s, public finance text books contained
something on tax admin, compliance and enforcement.
•In the 1960s, such literature began to disappear.
•In the 1970s, theory of optimal taxation further shifted
attention away from tax complexity.
•This has persisted in public finance textbooks, academic
literature and JEL classification.
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2. Neglect of Tax Complexity (contd.)
•Reasons for neglect: normative theory, conceptual issues,
data requirements, quality of data, negligible costs
•How to integrate tax complexity into theory of optimal
taxation?
•Little, if any, theoretical models of tax complexity (Slemrod
(1989) is an exception)
•Tax compliance costs = Hidden costs (Sandford (1973))
•Recent rising interests due to technology, VAT, enterprise
culture and growing tax complexity.
•Government’s commitments to reduce business red tape.
•Explosion of empirical studies around the world in the past
three decades
3. Review of Tax Complexity
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Meaning of complexity
•Different interpretations possible
•Slemrod (1999): Primary attributes approach (predictability,
enforceability, difficulty & manipulability)
•Evans & Tran-Nam (2010): Sequential approach (policy,
statutory, administrative & compliance complexity)
•Tran-Nam (1999): legal vs effective complexity
•Secondary attributes: comparative, revenue-equivalent for
effective complexity comparison & interactive
•Tax simplification also has various meanings
3. Review of Tax Complexity (contd.)
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Causes of complexity
•Within govt control: protection of tax revenue, use of tax law
for non-revenue policy objectives, distinction between taxes
& transfers, broadening of tax base, frequency of tax law
change, tax law drafting, admin practices, judicial traditions.
•Partly within govt control: tax culture, the economy
•Outside govt control: household and business preferences,
tax agent preferences, aggressive tax planning.
3. Review of Tax Complexity (contd.)
Indicators of tax complexity
•Number of taxes
•Length of tax code
•Readability of tax legislation
•Extent of use of tax agents
•Tax operating costs (sum of tax administrative and
compliance costs)
•Extent of tax disputes
•Tradeoff between relevance and precision.
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4. Costs of Tax Complexity
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•Some complexity of desirable
•A simple model: interaction of internal & external
factors and tax system giving rise to tax compliance
behaviour.
•Internal factors: tax morale & understanding of tax
requirements
•External factors: social norm & tax culture,
occupational characteristics, accounting rules &
practices, tax agent attitudes and practices
•Tax system: laws, bases, rates, admin practices,
tribunal & court decisions
•Taxpayer behaviour: trying to change the tax system,
compliant, unintentionally & intentionally non-compliant
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4. Costs of Tax Complexity (contd.)
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Direct costs
•Value of resources taken away from productive use to
operate the tax system (tax operating costs)
•Tax admin costs: incurred by tax administrators (other
tax authorities can also be included)
•Tax admin and compliance costs are transferrable.
•Meaning and measurement of tax compliance costs
are problematic
•Conceptual: unavoidable vs avoidable; unpreventable
vs preventable; compliance benefits (true benefits vs
transfers)
•Practical: Psychological costs, accounting/tax overlap,
implicit costs, transitional/recurrent costs.
4. Costs of Tax Complexity (contd.)
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Direct costs
•Value of resources taken away from productive use to
operate the tax system (tax operating costs)
•Tax admin costs: incurred by tax administrators (other
tax authorities can also be included)
•Tax admin and compliance costs are transferrable.
•Meaning and measurement of tax compliance costs
are problematic
•Conceptual: unavoidable vs avoidable; unpreventable
vs preventable; compliance benefits (true benefits vs
transfers)
•Practical: Psychological costs, accounting/tax overlap,
implicit costs, transitional/recurrent costs.
4. Costs of Tax Complexity (contd.)
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•Empirical studies: mainly survey based (response rate,
recollection, attribution)
•Tax compliance costs: 2%-10% of tax revenue and up
to 2.5% of GDP
•Internal labour costs dominate (about two thirds)
•Tax compliance costs are regressive (Australian
individual taxpayers represent an interesting case
study)
•Tax compliance costs show no sign of decreasing over
time despite tax simplification attempts
•Not easy to use tax compliance costs to examine how
tax complexity differs between countries or changes
over time
4. Costs of Tax Complexity (contd.)
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Indirect costs
•Two types: tax revenue losses & efficiency-like costs
•Tax revenue losses (aggressive tax planning or tax
evasion)
•Efficiency-like costs refer to losses in output due to
distorted behaviour of economic agents arising from
perceived or actual direct costs
•Example 1: sales avoidance strategy to stay below VAT
threshold
•Example 2: vareity reduction strategy to avoid dealing
with different VAT rates
•Example 3: inflow FDI reduction (Edmiston et al 2003,
Muller and Vogel 1012, Lawless 2013).
4. Costs of Tax Complexity (contd.)
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Macroeconomic costs
•Tax complexity as a tax has short-term, multiplier effect
as it flows through the economy
•TCC and indirect costs have negative effects on GDP
while TAC has a positive effect.
•MCTC = mTTCC + mI I  mG TAC
MCTC = Macroeconomic costs of tax complexity;
mT, mI, mG = Tax, Investment and Government
spending multipliers;
I = Reduction in investment due to indirect costs of tax
complexity.
•Since TCC is many times greater than TAC, it is likely
that MCTC > TCC + TAC
5. Conclusion
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•While efficiency costs is well established the costs of
tax complexity are not yet fully understood
•This paper has attempted to present a comprehensive
approach for measuring costs of tax complexity
•Three related costs of tax complexity are considered:
direct, indirect and macroeconomic costs.
•Implication 1: The principle of tax neutrality should be
expanded to include the deadweight losses induced by
tax complexity
•Implication 2: Current approach underestimates the
costs of tax complexity. Thus the case for tax
simplification can be strengthened.
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