The current tax system in the United States consists primarily of five types of taxes: (1) personal income taxes; (2) corporate income taxes; (3) social insurance taxes (employee and employer contributions for Social Security, Medicare, and unemployment compensation); (4) estate and gift taxes, and (5) a variety of other taxes such as excise taxes on goods and services. Table 1 summarizes several selected features of the current federal tax system. The definition of the tax bases, the tax rates, the various tax credits, and the specific characteristics of each taxpayer determine how much that taxpayer must pay to the U.S. Treasury. The total cost of taxes from a taxpayer’s point of view is the sum of the tax liability, the costs of complying with the tax system, and the efficiency costs that the system imposes, as shown in figure 1. In subsequent sections we discuss the various factors that cause the latter two types of costs. The costs of complying with the tax system are uncertain, but likely to be large—estimates are roughly on the order of about 1 percent of GDP. The costs include the computational, reporting, planning, and recordkeeping requirements of the tax system. Estimates of compliance costs are uncertain because taxpayers generally do not keep relevant records documenting their time and money spent complying with the tax system and many important elements of the costs are difficult to measure because, among other things, federal tax requirements often overlap with recordkeeping and reporting that taxpayers do for other purposes. The federal tax system imposes a wide range of recordkeeping, planning, computational, and filing requirements upon businesses and individuals. Complying with these requirements costs taxpayers time and money. Many of these requirements are complex, reflecting both the complexity of our modern economy and intent of policymakers to build progressivity and various incentives into the tax system. As shown in figure 2, these costs to taxpayers are above and beyond what they pay to the government in taxes. The tax compliance requirements for individuals include the documentation of their incomes and their qualifications for various exemptions, deductions, and credits available under the federal income tax. Although the documentation of income is straightforward for a large proportion of the individual taxpayer population who earn only labor and interest income and capital income within a retirement account, substantial numbers of taxpayers receive income from capital gains, rents, self-employment, and other sources that involve additional calculations and recordkeeping. In addition, many individuals must familiarize themselves with (or pay someone to advise them on) the sometimes complex rules for determining whether they qualify (and, if so, to what extent) for any of the numerous tax benefits in the federal tax code. Moreover, in cases where multiple tax expenditures have similar purposes, taxpayers may have to devote considerable time to learning and planning in order to make optimal use of these tax benefits. For example, the IRS publication Tax Benefits for Education outlines 12 tax expenditures, including 4 different tax expenditures for educational saving. Three of these savings tax expenditures—Coverdell Education Savings Accounts, Qualified Tuition Programs, and U.S. education savings bonds—differ across more than a dozen dimensions, including the tax penalty that occurs when account balances are not used for qualified higher education expenses, who may be an eligible beneficiary, annual contribution limits, and other features. Similarly, 3 other tax expenditures, all of which help students meet current costs—the Hope credit, Lifetime Learning credit, and the tuition deduction—differ in terms of eligibility criteria, benefit levels, and income-related phase-outs. The use of one of these tax expenditures can affect whether (or how) a taxpayer is allowed to use the other tax expenditures. Moreover, the use of one of these tax expenditures may affect a student’s eligibility for other forms of federal assistance for higher education, such as Pell grants and subsidized loans. Tax compliance requirements for businesses are even more extensive and complex than those for individuals. Rules governing the computation of taxable income, expense deductions, and tax credits of U.S. corporations that do business in multiple foreign countries are particularly complex. But even small businesses face multiple levels of tax requirements of varying difficulty. In addition to computing and documenting their income, expenses, and qualifications for various tax credits, businesses with employees are responsible for collecting and remitting (at varying intervals) several federal taxes on the incomes of those employees. Moreover, if the businesses choose to offer their employees retirement plans and other fringe benefits, they can substantially increase the number of filings they must make. Businesses also have information-reporting responsibilities—employers send wage statements to their employees and to IRS; banks and other financial intermediaries send investment income statements to clients and to IRS. Finally, a relatively small percentage of all businesses (which nevertheless number in the hundreds of thousands) are required to participate in the collection of various federal excise taxes levied on fuels, heavy trucks and trailers, communications, guns, tobacco, and alcohol, among other products. The tax filings and records of both individuals and businesses are subject to review by IRS. Attempts at tax evasion, unintentional filing errors, or differing interpretations of the tax law can all lead IRS to request more information from taxpayers and, possibly, to litigation, all of which would add to the taxpayers’ costs. It is difficult for researchers to estimate the total compliance costs of the federal tax system because taxpayers generally do not keep records of the time and money spent complying with that tax system. Moreover, many important elements of the costs are difficult to measure because recordkeeping and reporting to comply with federal tax requirements often overlap with recordkeeping and reporting that taxpayers do for other purposes; some costs that taxpayers incur in dealing with IRS may result from tax evasion, rather than tax compliance; and there is no consensus on the appropriate method for determining the dollar-value of each hour that an individual spends on tax compliance. Businesses and individual taxpayers have little, if any, motivation to keep records of the time and money that they spend specifically on complying with federal tax requirements. Consequently, when researchers attempt to collect data on compliance costs, they typically have had to contact samples of taxpayers, through surveys or interviews, and ask them for their best recollection of the total time and money they spent on particular compliance activities. Evidence from one past compliance cost study suggests that respondent recall error may be substantial. Moreover, conveying the appropriate definition of federal tax compliance costs to mail or telephone survey respondents and getting those respondents to apply that definition uniformly is difficult, as will be clear from the discussion below. In fact, most of the studies that we found had considerable difficulty getting taxpayers, particularly businesses, to respond at all. A high response rate is important for the accuracy of estimates, particularly for the population of business taxpayers that is highly diverse in terms of size, industry, and business organization and, therefore, is likely to be diverse in terms of its compliance costs. A major difficulty in measuring compliance costs is disentangling accounting and recordkeeping costs due to taxes from the costs that would have been incurred in the absence of the federal tax system. For example, where the rules regarding the calculation of income for tax purposes coincide with the rules for determining income for financial statement purposes, the additional costs of taxation can be minimal. Public corporations must file financial statements with the Securities and Exchange Commission; other businesses are required to provide financial statements to banks and other lenders when they are seeking credit. Similarly, many individuals need to document their income when applying for mortgages or financial aid for college. Moreover, most businesses and individuals must comply with state, and sometimes local, income tax filing requirements that are often very similar to those imposed by the federal tax system. Consequently, if one wishes to define the compliance costs attributable to the federal tax system as only those costs that would not exist in the absence of that system, then one needs to assume what the requirements of state and local tax systems, as well as those of financial accounting systems, would look like in the absence of the current federal tax system and make sure that none of the costs of complying with those requirements are included in the estimate of federal compliance cost. The studies that we reviewed typically exclude normal business accounting costs from their definition of federal tax compliance costs; however, they do not exclude the costs of complying with tax requirements that are imposed by both federal and state governments. Two additional definitional issues that have been discussed in the compliance cost literature are how to treat costs associated with either tax planning or tax evasion. Although tax planning expenses are excluded from the definitions of compliance costs established by the Paperwork Reduction Acts of 1980 and 1995, some studies that we reviewed do include such expenses in their definition of compliance costs. None of the studies we reviewed recommended the inclusion of costs associated with illegal tax evasion; however, it is difficult for researchers to completely exclude tax evasion costs from their estimates because, in many cases, the determination of whether a particular activity constitutes tax evasion or not is not made until a year or more after the activity is completed (and recorded in a survey). There is no consensus among researchers regarding the appropriate monetary value to be assigned to each hour of time spent on tax compliance activities. Some of the many issues involved in the choice of the appropriate value are: whether to use different values for time that is taken away from the taxpayer’s leisure and time taken away from additional hours at work; whether to use different values for time spent on activities that the taxpayer could have paid someone to do and time spent on activities that only the taxpayer could do; whether to relate the value to each taxpayer’s own hourly wage rate or to some uniform wage rate; and whether to use a before-tax or after-tax wage rate. The choice of the monetary value of an hour spent on tax compliance obviously will have a substantial effect on the estimated magnitude of aggregate compliance costs. The government’s Information Collection Budget (ICB), for the Department of the Treasury, annually estimates the time that taxpayers spend on prefiling and filing activities for every form issued by the Treasury. The vast majority of these forms are tax related. Treasury has estimated that during fiscal year 2004 individuals, businesses, and exempt organizations spent a total of 6.4 billion hours on Treasury’s forms. Treasury does not convert this time estimate into a monetary value. If this time burden were monetized at rates between $15 per hour and $30 per hour (the range used for individual taxpayers in the studies that we found), the total cost would amount to between about $100 billion and $200 billion. Many analysts within Treasury and outside believe that the ICB estimates are not very accurate. The estimates are based primarily on an IRS model that was developed with survey data for tax year 1983. The simplicity of the model’s approach for updating the data each year leaves it with a very limited ability to adjust for changes in compliance burden resulting from changes in tax policy or tax system administration. Indeed, in an effort to more accurately measure paperwork burden, IRS is currently developing a revised methodology for estimating the compliance burden individuals incur when complying with the U.S. tax system. The new model will reflect a change in the approach for measuring burden: it focuses on the taxpayer and the taxpayer’s characteristics rather than the forms the taxpayer uses. Key drivers of taxpayer burden in the model are the taxpayers’ activities and the method of return preparation (by a paid preparer, by the taxpayer with tax preparation computer software, or by the taxpayer without computer assistance). In addition, IRS is also working on new methodologies for estimating the compliance burdens of various types of businesses and tax-exempt entities, and the burdens associated with postfiling activities. Most of the other estimates of the compliance burden that we found for large segments of the taxpayer population were produced by contractors to IRS or by analysts who used IRS’s data. The disparities among the estimates, their likely margins of error, and their incompleteness (few include postfiling costs, such as audits, and all are limited to the income tax) prevent a more definitive conclusion about the total compliance burden of the U.S tax system. Studies we found that focus on the compliance costs of individual taxpayers estimate it to be between $67 billion and a little over $100 billion per year. The variation in these estimates is primarily attributable to the wide range in monetary values that the different studies apply to an hour spent on tax compliance activities. These studies are summarized and compared in table 2. Studies we found that focus on the compliance costs of businesses estimate them to be between about $40 billion and $85 billion per year. None of these estimates include the costs to businesses of collecting and remitting income and payroll taxes for their employees. The accuracy of these business compliance cost estimates is uncertain due to the low rates of response to their data collection surveys. In addition, the range in estimates across the studies is due, among other things, to differences in monetary values used (ranging between $25 per hour and $37.26 per hour), differences in the business populations covered, and differences in the tax years covered. These studies are summarized and compared in table 3. Frequent changes to the tax code over time reduce the relevance of past estimates of compliance costs to policymakers who are interested in the costs of the current system. Since the comprehensive tax reform of 1986 there have been changes to the tax code every year; many of these changes can be characterized as major. Two examples of the numerous changes that have likely affected compliance burden are the revenue provisions of the Small Business Job Protection Act of 1996 that tightened the pension nondiscrimination rules that businesses must follow; and the creation of Hope and Lifetime credits for post-secondary education (in the Taxpayer Relief Act of 1997); the fact that taxpayers must chose between the two credits adds to their need for tax planning. The estimates presented above do not represent the potential cost savings to be gained by replacing the current federal tax system. Any replacement tax system will impose significant compliance costs of its own. Moreover, given that many state and local government income taxes depend upon the same compliance activities as the federal income tax does, taxpayers would still bear the costs of those activities unless those other governments replaced their own taxes to conform to the new federal system. In addition, if some of the subsidies, such as the earned income tax credit and the research tax credit, that are provided by the current federal tax system are replaced by spending programs under a reformed system, tax compliance costs may be reduced, but only as a result of their being shifted to those new programs. Similarly, if a replacement tax system no longer requires businesses and individuals to compute and document their incomes, those businesses and individuals will still need to document their incomes for borrowing and other purposes, and government statistical agencies will incur expenses to replace the data that they currently obtain from income tax returns. Economic efficiency costs occur when tax rules cause individuals to change their work, savings, consumption, and investment behavior in ways that ultimately leave them with a combination of consumption and leisure (now and in the future) that they value less than the combination they would have obtained under a tax system that did not distort their behavior. Estimating efficiency costs is very challenging because the tax system has such extensive and diverse effects on behavior. We found no comprehensive estimates of the efficiency costs of the current federal tax system. However, we did find some studies that estimate the efficiency costs attributable to selected aspects of the current system. Although none of these studies, either individually or in the aggregate, provide a basis for estimating the total efficiency cost of the tax system, they do indicate that those total costs are likely to be large. The more comprehensive estimates show costs on the order of 2 to 5 percent of GDP each year. However, the efficiency cost of the current tax system may not fall within that range because of uncertainty surrounding taxpayer’s behavioral responses to tax rules, changes in the tax code and the economy since the mid-1990s, and the studies do not cover all of the sources of efficiency costs. Many aspects of the federal tax system provide incentives or disincentives for taxpayers to undertake particular activities. Some of these incentives and disincentives were intentionally designed into the system; others are unintended consequences of rules designed to achieve other objectives, such as equity or increased revenue yield. By changing the relative attractiveness of highly taxed and lightly taxed activities, taxes alter decisions such as what to consume and how to invest. Households and firms generally respond to taxes by choosing more of lower taxed items and less of higher taxed items than they would have otherwise. When taxpayers alter their behavior in response to tax rules, they often end up with a combination of consumption (broadly defined) and leisure that they value less than the combination they could have achieved if they made decisions free of any tax influences. Economists refer to this reduction in value as a “welfare loss” or an efficiency cost; they also generally refer to behavioral changes in response to taxes as “distortions,” even though not all changes have negative consequences. As an example of the efficiency costs of taxes, suppose an investor is choosing between two potential investments, one that has an expected return of $1.10 on every dollar invested and a second that has an expected return of $1.20. If neither investment is taxed, or if the investments are taxed equally, the investor will choose the second investment with its higher economic rate of return. However, if the first investment continues to be untaxed, while the second is subject to a 10 percent tax, the decision will be based on the investments’ after-tax rates of return. In this case the after-tax return on the first investment continues to be $1.10 for every dollar invested, while the after-tax return on the second investment is now $1.08. An investor would choose the first investment because it has a higher after-tax return. This tax distortion causes investors to earn $.10 less on every dollar invested, relative to the no-tax case, even though no tax is paid to the government. This decline in income ultimately leads to lower total consumption. Efficiency gains or costs are not the same as increases or decreases in economic output (normally measured in terms of GDP). For example, a reduction in taxes on wages could encourage some individuals to increase the number of hours they work, which in turn would increase economic output and the amount of consumption those workers could achieve. However, the welfare gain to these individuals may be considerably less than the increase in their consumption because they would have to forego some leisure time that they value in order to achieve the gain in welfare. In fact, some researchers who have examined both the output and efficiency effects of replacing the current tax system with various alternatives have reached similar conclusions concerning output effects while reaching different conclusions concerning the efficiency effects of similar alternatives. The efficiency gain or loss due to a change in a tax system is defined as the difference between total welfare that is achieved under the existing tax system and that which would be achieved under the replacement system that raised the same amount of revenue. The total efficiency cost of the current federal tax system would have to be estimated by comparing it to a tax system that raised the same amount of revenue while generating no efficiency costs at all—in other words, a tax system that had no effect on taxpayers’ behavior at all. Although such distortion-free tax systems can be designed in theory, none exist as primary sources of revenue in practice because they are generally viewed as inequitable. Estimating the efficiency costs of the federal tax system is an enormous, complicated, and uncertain task, given the complexity of existing tax rules, the breadth and diversity of the U.S. economy and population, and the limited empirical evidence available regarding how individuals and businesses change their behavior in response to tax rules. In order to obtain a precise estimate of the efficiency costs researchers would need to identify all of the significant incentives and disincentives imbedded in the federal tax system; they would also need to know the extent to which large, heterogeneous populations of individuals and businesses have changed their behaviors in response to these incentives. In practice, researchers have not been able to obtain and analyze all of the detailed data they need to produce efficiency cost estimates that are free from a large degree of uncertainty. The mathematical models that are used to analyze the important interrelating and cascading effects of the entire tax system, or even significant components of the system, are quite complex, even when researchers limit their examination to highly simplified representations of the actual taxes. It is impractical to incorporate all of the significant details of tax rules that result in efficiency costs. Similarly, data constraints and computational practicality lead researchers to limit the extent to which their models reflect the variations in behavioral responses to various tax rules across large and heterogeneous populations of businesses and individuals. Finally, researchers attempting to estimate efficiency costs often have little, or conflicting, empirical evidence upon which to base their assumptions about various behavioral responses to tax distortions because the underlying research into those behavioral responses is, itself, subject to considerable uncertainty. For example, one piece of information that is critical to the estimation of efficiency costs is the extent to which individuals’ taxable incomes change in response to tax changes. Researchers have had difficulty estimating this responsiveness because of the difficulty of controlling for all of the other factors that affect income growth, such as changes in the economic environment, returns to investments in education, and the changing age distribution of the population. Moreover, this responsiveness is likely to be different for different subpopulations of taxpayers. None of the studies we reviewed provides a comprehensive estimate of the efficiency cost of the U.S. federal tax system since the tax reform of 1986. However, a variety of studies do provide some evidence that the efficiency costs are large. All of these studies are summarized in table 4. The more comprehensive studies we found show costs on the order of 2 to 5 percent of GDP each year (as of the mid-1990s). The other studies that we reviewed examined more limited aspects of the tax system’s distortions. The efficiency cost estimates for those selected distortions cannot be summed directly to an overall estimate; however, they are each significant enough to support the conclusion that the combined cost of all distortions is large. The two studies with the broadest scopes among those that we reviewed were by Jorgenson and Yun and by Feldstein. The first set of authors estimated that the efficiency cost of federal taxes on capital and labor income in 1997 was equal to about 19.5 percent of the revenues collected from those taxes. Applying this percentage to federal corporate and personal income tax collections in 1997 would yield efficiency costs of about $200 billion or, roughly, 2.5 percent of GDP in that year. Feldstein examined the effects of several distortions caused by the federal personal income tax and payroll taxes, including those related to decisions about how much to work and what to consume. He estimated that these distortions resulted in efficiency costs of between $137 billion and $363 billion in 1994 (depending on his assumptions regarding the size of taxes effects on various decisions). Those estimates were roughly equivalent to between 2 and 5 percent of GDP in 1994. The other studies that we found focused on more limited aspects of the tax distortions caused by the federal tax system. For example, Cai and Gokhale examined how selected aspects of the federal personal and corporate income taxes distorted the choices between savings and consumption and found that these distortions generated $45 billion per year in efficiency costs as of 1995. As another example, Holtz-Eakin and Marples found that the distorting effect of the estate tax on choices among consumption, leisure, and wealth accumulation resulted in efficiency costs of over $38 billion in 1999. The estimates from the various studies shown in table 4 cannot be combined to obtain a comprehensive estimate of the current tax system’s efficiency costs for several reasons. First, no combination of the estimates covers all of the tax system’s distortions (e.g., none of the estimates cover the effects of payroll taxes on savings). Second, an estimate of the costs arising from all of the tax system’s distortions can only be made by examining the removal of all of the distortions simultaneously. Finally, the various estimates are made for different years and, therefore, reflect different tax systems, each of which is somewhat different than today’s system. As noted earlier, there have been frequent and significant changes to the tax system since 1986. Even as recently as 2001 and 2003 there have been changes that are likely to have affected the efficiency costs of federal income taxes. For example, the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA) decreased the marginal tax rates on individual income and estates and increased the exemption from estate taxes. These changes could have decreased the efficiency cost for individuals. Also, Gravelle (2004) notes that the temporary reduction in taxes on dividends contained in the Jobs and Growth Tax Relief Reconciliation Act of 2003 contributed to a reduction of the corporate/noncorporate distortion and its efficiency costs. Nevertheless, the estimated efficiency costs associated with the selected distortions are significant enough individually to suggest that the total efficiency cost of the tax system is large. We also reviewed a number of other studies that estimated the difference in efficiency costs between existing federal income taxes and potential substitutes for those taxes. These estimates do not represent the absolute costs of the existing taxes because the substitute taxes all generate efficiency costs of their own; however, they would (to the extent that they are accurate) represent lower bounds for those costs. The findings of these studies varied considerably, depending on the nature of the taxes that were presumed to replace the federal income taxes. For example, Lim Rodgers and Jorgenson and Wilcoxen found that there would be little, if any, efficiency gain from replacing the existing income taxes with a consumption-based flat tax. In contrast, Jorgenson and Yun estimated that the efficiency gains of replacing income taxes with a pure flat-rate income and/or sales tax would yield gains of about $210 billion per year (measured in 1997 dollars). As noted earlier, considerable uncertainty surrounds all of the estimates we have cited. The estimation of efficiency costs involves complicated modeling based on numerous assumptions about the behavioral responses of individuals and businesses to changes in taxes and other factors. Results are often quite sensitive to the assumed magnitude of key responses and those assumptions are often based on empirical research that continues to evolve over time or, in other cases, has yet to be undertaken. For example, the consensus of recent research is that individuals are less responsive to changes in taxes than Feldstein assumed them to be when he made his estimates. As another example, Holtz-Eakin and Marples noted that there was significant disagreement in the empirical research over one of the factors that was key to their estimate—the extent to which actual bequests differed from intended bequests. As some of the results presented in the preceding section demonstrate, the extent to which efficiency gains could be realized by switching to an alternative tax system depends critically on the detailed characteristics of the alternative. All of the alternative tax system proposals that have received serious consideration in recent decades would have imposed significant efficiency costs. Moreover, in assessing the potential efficiency gains from any tax reform proposal it is also important to consider compensating changes that may be made on the spending side of the federal budget. For example, if any tax expenditures in the current federal income taxes are replaced by grants, spending programs, regulations, or other forms of nontax subsidies, those subsidies can result in efficiency costs similar in magnitude to those associated with the tax expenditures they replaced. We provided a draft of this report in August 2005 to the Commissioner of Internal Revenue. We received technical comments via e-mail from the IRS Office of Research. Where appropriate, we made changes in our report in response to these comments. As agreed, unless you announce the contents of this report earlier, we plan no further distribution until 30 days from the date of this report. At that time, we will make copies available to others on request. In addition, the report will be available at no charge on the GAO Web site at http://www.gao.gov. If you or your staff have any questions on matters discussed in this report or would like additional information, please contact me at (202) 512-5594 or whitej@gao.gov. Contact points for our Offices of Congressional Relations and Public Affairs may be found on the last page of this report. Key contributors to this report were James Wozny and Donald Marples. Auerbach, Alan J. “Tax Reform, Capital Allocation, Efficiency, and Growth.” in Economic Effects of Fundamental Tax Reform. Edited by Henry J. Aaron and William G. Gale. 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Washington, D.C.: July 2005. Giertz, Seth. Recent Literature on Taxable Income Elasticities. Technical Paper Series no. 2004-16. Washington, D.C.: Congressional Budget Office, 2004. Gravelle, Jane. “The Corporate Tax: Where Has It Been and Where Is It Going?” National Tax Journal 57, no. 4 (2004). ----- “Differential Taxation of Capital Income: Another Look at the 1986 Tax Reform Act.” National Tax Journal 42, no. 4 (1989). ----- and Laurence Kotlikoff. “Corporate Tax Incidence and Inefficiency When Corporate and Noncorporate Goods Are Close Substitutes.” Economic Inquiry 31 (1993). Guyton, John, John O’Hare, Michael Stavrianos, and Eric Toder. “Estimating the Compliance Cost of the U.S. Individual Income Tax.” National Tax Journal 56, no. 3 (2003). Holtz-Eakin, Douglas, and Donald Marples. “Distortion Costs of Taxing Wealth Accumulation: Income Versus Estate Taxes.” National Bureau of Economic Research Working Paper 8261, National Bureau of Economic Research, 2001a. Holtz-Eakin, Douglas, and Donald Marples. “Estate Taxes, Labor Supply, And Economic Efficiency.” Center for Policy Research Special Report. Washington, D.C.: American Council for Capital Formation, 2001b. Joint Committee on Taxation. The Joint Committee on Taxation Tax Modeling Project and 1997 Tax Symposium Papers. JCS-21-97. Washington, D.C.: Joint Committee on Taxation, 1997. Jorgenson, Dale, and Kun-Young Yun. Investment Volume 3: Lifting the Burden: Tax Reform, the Cost of Capital, and U.S. Economic Growth. Cambridge, Massachusetts: The MIT Press, 2001. Jorgenson, Dale, and Peter Wilcoxen. “The Effects of Fundamental Tax Reform and the Feasibility of Dynamic Revenue Estimation.” In The Joint Committee on Taxation Tax Modeling Project and 1997 Tax Symposium Papers. JCS-21-97. Washington, D.C.: Joint Committee on Taxation, 1997. Liu, Liqun, and Andrew Rettenmaier. “The Excess Burden of the Social Security Payroll Tax.” Public Finance Review 32, no. 6 (2004). 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Summary: In 2005, Americans will pay about $2.1 trillion in combined federal taxes, including income, payroll, and excise taxes, or about 16.8 percent of Gross Domestic Product (GDP). However, the amount of taxes paid does not reflect the total cost to taxpayers of the federal tax system. In addition to taxes paid, taxpayers also bear compliance costs and efficiency costs. Understanding the magnitude of these additional costs is important because every dollar spent on compliance and lost due to inefficiency represents a dollar that society could have spent for other purposes. In response to a congressional request for information on the magnitude of the compliance and efficiency costs of the current federal tax system, this study describes the nature of these costs, presents the difficulties associated with estimating them, and summarizes existing estimates of their magnitude. GAO did not make independent estimates of compliance or efficiency costs nor did we replicate any of the studies. GAO is not making any recommendations in this report. Complying with the federal tax system costs taxpayers time and money. Estimating total compliance costs is difficult because neither the government nor taxpayers maintain regular accounts of these costs and federal tax requirements often overlap with recordkeeping and reporting that taxpayers do for other purposes. Although available estimates are uncertain, taken together, they suggest that total compliance costs are large. For example, combining the lowest available estimates for the personal and corporate income tax yields a total of $107 billion (roughly 1 percent of GDP) per year. As noted, whether this is a definitive lower bound for compliance costs is uncertain. The tax system also results in economic efficiency costs because tax rules cause individuals to change their behavior in ways that ultimately leave them with lower-valued combinations of consumption and leisure than they would have obtained if the tax system did not affect their behavior. Estimating efficiency costs is very challenging because the tax system has such extensive and diverse effects on behavior. In fact, we found no comprehensive estimates of the efficiency costs of the current federal tax system. The two most comprehensive studies we found suggest that these costs are large--on the order of magnitude of 2 to 5 percent of GDP each year (as of the mid-1990s). However, the actual efficiency costs of the current tax system may not fall within this range because of uncertainty surrounding taxpayers' behavioral responses, changes in the tax code and the economy since the mid-1990s, and the fact that the two studies did not cover the full scope of efficiency costs. The goal of tax policy is not to eliminate compliance and efficiency costs. The goal of tax policy is to design a tax system that produces the desired amount of revenue and balances the minimization of these costs with other objectives, such as equity, transparency, and administrability. In addition, whether compliance and efficiency costs could be reduced by redesigning the tax system and, if so, by how much would depend critically upon the detailed characteristics of the new tax system.