C H A P T E R 1 2
T H E D E S I G N O F T H E TA X S Y S T E M
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For example, suppose that the government taxes 20 percent of the first $50,000
of income and 50 percent of all income above $50,000. Under this tax, a person who
makes $60,000 pays a tax of $15,000. (The tax equals 0.20
⫻
$50,000 plus 0.50
⫻
$10,000.) For this person, the average tax rate is $15,000/$60,000, or 25 percent. But
P
EOPLE RUNNING SMALL BUSINESSES ARE
most aware of the administrative bur-
den of the tax system. Small firms must
comply with many of the same laws as
large ones. Yet, because of their size,
compliance can take a much larger frac-
tion of their revenue. According to one
study, the administrative burden is ten
times larger
for small firms than for
large firms. The following article de-
scribes some of these costs.
O b e y i n g t h e Ta x L a w s :
S m a l l B u s i n e s s ’s B u r d e n
B
Y
R
OBERT
D. H
ERSHEY
, J
R
.
In the grand scheme of a federal system
that collects more than $1 trillion a year,
Dante’s Restaurant, Inc., a modest
three-city chain in Pennsylvania, counts
for little.
But to people like Lewis Kamin,
Dante’s controller, the Internal Revenue
Code is a year-round headache. There
are the biweekly
remittances of Social
Security and withheld income tax, quar-
terly reports of payroll and unem-
ployment taxes, quarterly estimated
corporate income taxes, and, of course,
the maintaining of various records,
including tips, W-4s for withholding, and
I-9 citizenship forms.
All this doesn’t count the ubiquitous
state and local levies that in Dante’s
case are complicated because liquor-
license considerations mean each of its
ten restaurants must be separately
incorporated.
“There
is a lot to watch, a lot to
worry about,” Mr. Kamin grumbled. . . .
This is the real-world side of Ameri-
can taxation, the federal chunk of which
is a system based on a monumentally
complex set of laws and regulations that
was just one-third its current size when
Jimmy Carter called it “a disgrace to the
human race.”
The code is administered by a
115,000-member Internal Revenue Ser-
vice army with a $7 billion budget. But
that amount is dwarfed by what taxpay-
ers themselves spend on meeting their
obligations.
Estimates of what it costs American
businesses to comply with federal tax
law reach into
the hundreds of billions of
dollars a year. . . . Big companies are un-
der almost continuous audit. The 1992
return for one giant company ran to
21,000 pages and 30 volumes. But
the heaviest burden by far falls on small
business.
In fact, according to Arthur P. Hall, a
senior fellow at The Tax Foundation, the
local hardware store, delicatessen, or
gas station with assets of less than $1
million—a category embracing 90 per-
cent of the nation’s corporations—
spends $390 for each $100 it sends to
Washington. Put another way, the gov-
ernment got just $4.1 billion from these
businesses in 1990, compared with the
$15.9 billion
they spent producing the
basic corporate forms, the 1120 and
1120S.
“What this means is that the cor-
porate income tax is a very inefficient
revenue source for the federal govern-
ment,” Mr. Hall said. . . .
Although complaints about the tax
system are often aimed at the I.R.S.,
businesspeople and policymakers gener-
ally contend that
the real fault lies with
Congress and its frequent, often well-
intentioned tinkering with the law. The
resulting complexity is taking an ever-
mounting toll on respect for the system,
and thereby undermines the willingness
of even the best-intentioned taxpayer to
figure out what he or she should pay. . . .
Since 1981, Washington has put
ten major tax laws on the books, gener-
ating changes whose cumulative effect
“is pretty staggering for the small busi-
nessperson,” said Edward Koos, a tax-
policy
lawyer at the Small Business
Administration.
Harold Apolinsky of the Small Busi-
ness Council says 9,371 code sections
have been amended since 1981, a total
that owes much to the lobbying and
campaign contributions of the powerful.
“It appears to me that small business
just has no clout,” Mr. Apolinsky said.
“Big business tolerates it,” he added,
referring to the resulting complexity.
“Small business really can’t.”
S
OURCE
:
The New York Times,
January 30, 1994,
Business Section, p. 4.
I N T H E N E W S
Small Business and
the Tax Laws
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PA R T F O U R
T H E E C O N O M I C S O F T H E P U B L I C S E C T O R
the marginal tax rate is 50 percent because the amount of the tax would rise by
$0.50 if the taxpayer earned an additional dollar.
The marginal and average tax rates each contain a useful piece of information.
If we are trying to gauge the sacrifice made by a taxpayer, the average tax rate is
more appropriate because it measures the fraction of income paid in taxes. By con-
trast, if we are trying to gauge how much the tax system distorts incentives, the
marginal tax rate is more meaningful. One of the
Ten Principles of Economics
in
Chapter 1 is that rational people think at the margin. A corollary to this principle
is that the marginal tax rate measures how much the tax system discourages peo-
ple from working hard. It is the marginal tax rate, therefore, that determines the
deadweight loss of an income tax.
L U M P - S U M TA X E S
Suppose the government imposes a tax of $4,000 on everyone. That is, everyone
owes the same amount, regardless of earnings or any actions that a person might
take. Such a tax is called a
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