April 16, 2007

The People who Brought you Tax Day

By: AFF Editors

Taxes cause pain in two ways. Most directly they make you poorer. Also they take up your time. Put another way—taxes are too high and too complex. I should qualify that. Taxes are too complex for the good of the economy, too complex for families, and too complex for small businesses. For big business and for Washington lobbyists, complexity means profit.

University of Michigan professor Joel Slemrod, possibly the nation’s leading expert on tax law and business, laid out the groundwork for this case in a paper titled “The Income Tax Compliance Cost of Big Business.” His paper, which examined the costs of hiring outside tax experts, in-house tax experts, legal experts, accountants, and all of the other labor and materials costs of complying with the tax code, found, unsurprisingly: “As companies get larger, their total cost of tax compliance increases, but it increases at a rate less than proportional to the increase in company size.”

In other words, smaller businesses are hit harder than bigger businesses by the cost of obeying tax law. Slemrod’s study, which compared big businesses to very big businesses showed this in hard numbers. Relatively small employers (fewer than 1,000 employees) spent, on average, $696,500 per year just complying with the tax code (not including the taxes they actually paid).

Super-big companies, with more than 40,000 employees averaged about $5,180,900 in tax compliance costs. That means that per employee, smaller companies paid $1,203.40 in tax compliance, while the biggest companies paid $63.60 per worker in tax compliance.

Judging by another measure, the same finding comes across. Firms with assets less than $250 million spent $580,500 per year in tax compliance, or 0.40% percent of their total assets. Companies with over $10 billion in assets spent 0.03% of them on tax compliance.

Depending on the measure, the smaller firms in Slemrod’s study pay proportionally 13 times to nearly 20 times more in tax compliance than the largest firms. This means that a more complex tax code, whatever burdens it imposes on big business, could become a boon to the leader in any industry by creating barriers to entry and squelching competition.

Heritage Foundation tax expert Dan Mitchell has witnessed this dynamic firsthand in his advocacy of replacing our complex federal tax code with a flat tax at a low rate with almost no deductions. “I’ve spoken to dozens of groups about the flat tax,” he said to me over lunch on Capitol Hill one day, “and by far the most negative reaction I’ve gotten has been from big business groups.”

The most insidious intention to read into this opposition to tax simplification is that big businesses understand Slemrod’s findings and want to crush their smaller competition.

The more likely explanation is subtler and more innocent. The first factor at play is the investment already made. Any well-run large company has already structured its income, assets, investments, liabilities, and expenditures in such a way as the reduce tax exposure and maximize benefits from tax credits and tax deductions. Likely they have structured their employee benefit plans around those benefits that are untaxable and that might be taxed in a flat-tax system. They probably have created special purpose entities that would serve no purpose were the tax code simpler. Almost certainly they have hired or at least contracted for tax advisors and tax lawyers, both costly investments.

The negative reaction to Mitchell’s idea of a simple flat tax likely reflects this thought by big business: “We’ve wasted so much time and money playing by the IRS’s stupid rules, and now you’re going to get rid of them? No fair!”

A second factor is that the voices skeptical of big business may not be speaking for their business as a whole, but for their own personal interests. This is this the principle-agent problem.

In a company, who would go see a Washington tax expert speak about tax policy? Perhaps the CEO would, or maybe the Chief Financial Officer. More likely, though, Mitchell’s corporate audience consists of the company’s hired tax experts. These people have jobs because the CEO and the CFO cannot figure out the tax code. A tax advisor in a world with a flat tax would be like a fur coat salesman in the Caribbean.

Consider the pedigree of many corporate tax professionals. One prime example is Pamela Olson. Currently, she is a partner at the law firm Skadden, Arps, Slate, Meagher & Flom. She came there from the U.S. Department of the Treasury where she served as the Assistant Secretary for Tax Policy, making her one of the very highest-ranking government officials on the issue of taxes. As Treasury’s website puts it, that position “has supervisory responsibility for providing the Secretary of the Treasury with policy analysis, advice and recommendations relating to all aspects of domestic and international issues of Federal taxation, including all legislative proposals, regulatory guidance, and tax treaties.”

In earlier administrations, Olson held positions at the Internal Revenue Service, including in the chief counsel’s office, and as “an Attorney-Advisor in the Legislation and Regulations Division.” It’s no wonder Skadden would want to hire her, and its no wonder corporate clients would want her services when they want to learn how to pay lower taxes while avoiding legal trouble.

There are hundreds of people like Olson, who bounce back and forth between forming laws and regulations, and then advising corporations on how to deal with the laws and regulations. These are the kind of people who fill Mitchell’s corporate audiences. “It is definitely, unquestionably, in their interest to increase the bureaucracy,” Mitchell says. These are also the kind of people whom small business cannot afford to hire. These are the people who have brought you the complex tax code.

Tim Carney is the author of The Big Ripoff: How Big Business and Big Government Steal Your Money. He is the Warren T. Brookes Journalism Fellow at the Competitive Enterprise Institute.