Using Tax Reform to Reveal the Hidden Cost of the Administrative State
J. Kennerly Davis, Jr.
According to data recently released by the Bureau of Labor Statistics, American households on average spent more last year on federal, state and local taxes ($10,489) than they did on food and clothing combined ($9,006). Think about that. These official figures confirm what Americans have known generally for a long time – taxes impose a significant economic burden.
At least the cost of taxes has been accurately quantified. The official figures are known and publicly available to support an informed debate about the cost of taxes and the benefits that may result from public spending. Not all the costs of government are so transparent.
In addition to taxes, the government imposes an enormous additional economic burden on American households through massive regulations that direct and restrict virtually every aspect of our daily existence. Unlike taxes, the cost of these regulations is largely hidden. There is no mechanism, no agreed upon method or procedure to capture and make public all the costs that businesses and individuals must incur to comply with the regulations that govern their operations and activities.
Some analysts estimate that the total cost to comply with federal regulations now approaches $2 trillion per year. To cover their compliance costs, American businesses are forced to raise the prices they charge for the goods and services they sell. Businesses are also forced to cut their other costs, reducing what they can spend on wages, employee benefits, research and development, and production facility upgrades.
In this way, regulatory compliance costs impose an enormous burden on the American economy, a hidden tax that we all must pay in higher prices and smaller paychecks. If this hidden tax were spread evenly to all American households, the share for each household would amount to approximately $15,000 – fifty percent higher again than all the other taxes the household must pay!
The $2 trillion figure is an estimate. Other estimates are much smaller. In the absence of any agreed upon procedure to calculate regulatory compliance costs, there is no way to reconcile such differences. There is no way to collect and disseminate a single set of data that could support an informed debate about the cost of regulations compared to the benefits that may result from their implementation. Is there any way to remedy this situation, any way to accurately quantify and make public the hidden cost of the regulations we must comply with?
Congress is hard at work on significant tax legislation. This effort presents Congress with an opportunity to consider whether and how tax reform might be used to bring transparency to the hidden costs of federal regulation.
One way that Congress could enhance transparency is by amending the tax code to include a fully refundable and transferable tax credit for one hundred percent of the actual incremental costs incurred going forward by a regulated entity to comply with the regulatory requirements imposed on the entity by federal agencies. There are many strong points in favor of such a tax credit. They include the following:
- It is appropriate to reimburse a regulated entity for its compliance costs. Such costs are not fines or penalties or awarded damages resulting from a failure to comply with regulatory requirements. Such costs are incurred by a blameless entity in the normal course of business to maintain compliance with new regulations that the government has determined have societal benefits in excess of the cost to implement them. The societal benefits are dispersed to the public, to taxpayers in general. The proposed credit would provide a mechanism for those benefitted taxpayers to reimburse the entities that funded the benefits resulting from the new regulatory requirements.
- A refundable transferable tax credit would fully and consistently reimburse an entity for its compliance costs. Unlike the tax deduction against income currently available for compliance costs, reimbursement would not be contingent upon the entity having taxable income. Reimbursement for compliance costs should not depend on the taxable income of the regulated entity. All such entities should receive equal treatment.
- The tax credits claimed following enactment of the proposal would clearly record total compliance costs on the financial accounts of the federal government. By bringing the currently hidden cost of regulation out into the open for all to see, the tax credit would make a tremendous contribution to transparency by generating information that could finally support a truly meaningful national discussion about the costs and benefits of regulation.
- By imposing the cost of regulation on the regulator instead of the regulated, the tax credit would compel federal agencies to conduct benefit cost analysis with the same discipline that now characterizes the benefit cost analysis conducted by private sector businesses.
- By putting the actual cost of regulation on the books of the federal government, the tax credit would provide the kind of post-implementation cost assessment that is often called for today, but seldom carried out.
- The tax credit, available equally to all regulated entities, would eliminate the economic advantage that larger established companies currently have over their smaller competitors when it comes to bearing the cost of regulatory compliance. By levelling the field in this way, the tax credit could reduce the incentives that established companies have to support burdensome regulations that they can afford to comply with more easily than their smaller, less well-established competitors.
- By reducing the incentives to use regulation to establish competitive advantage, the tax credit could reduce the amount of corporate resources currently diverted from productive endeavors and innovation to rent seeking.
- Such a tax credit would be fully self-funding because compliance costs will be incurred, and credits claimed only when an agency determines that the societal benefits of a new regulation justify the compliance costs resulting from its implementation.
- By making regulated entities indifferent to the cost of compliance, such a tax credit would eliminate the incentives that regulated entities now have to engage in costly and time-consuming disputes with agencies about the results of agency analysis. Federal agencies have always claimed that their benefit cost analysis is the product of technical expertise that should be respected and accepted. If the federal government is to bear the cost to implement a new regulation, then everyone concerned is likely to respect and accept the analysis that supports the decision to implement.
- By eliminating the need for a regulated entity to absorb and/or pass through its compliance costs, such a tax credit would eliminate the economic distortions that currently result from the imposition of regulatory burdens, e.g., lower wages, higher prices and the diversion of capital from productive applications to compliance.
There are many benefits that would result from the enactment of the proposed tax credit. The numerous benefits make a strong case that Congress should give serious consideration to the proposal. Let the debate begin!