Tax day is upon us, and millions of Americans will be concentrating on something they would prefer not to think about – the frustrations and complexities of the tax code. This is especially true for small business owners, as the burden to comply with the tax code hits them the hardest.
Research from the Office of Advocacy of the U.S. Small Business Administration spotlights just how uneven the tax compliance burden is for small businesses. Small businesses with fewer than 20 employees annually spend $1,304 per employee to comply with federal income tax regulations. That is almost twice as much as large firms spend.
One reason for the high per employee cost to the smallest firms is the complexity in the tax code. Compliance with the tax code places a substantial paperwork and recordkeeping burden on any firm with a payroll, even before the first paycheck is cut. Many of these costs are fixed. Bigger firms can spread the costs over a greater number of employees, thus reducing the cost per employee. For small firms these costs cannot be so easily absorbed.
Moreover, tax rebates, credits, deductions, investments, offsets and more require an intimate knowledge of legalese in the tax code. The recordkeeping required to take advantage of these "tax expenditures" (Washington, D.C., speak for letting taxpayers keep more of their own money) can be time consuming and hyper-meticulous. The number of restrictions on the various tax expenditure programs, as well as the recordkeeping burdens, contributes to the tax code’s complexity.
A second factor exacerbates issues of complexity, namely uncertainty over future tax obligations. Yearly tinkering with the tax code, ever-changing deadlines, and expiring provisions make extended planning risky and oft times futile. In this environment, entrepreneurs have increased difficulty with both setting and executing business plans. The uncertainty affects their planning horizons, and reduces both the expected benefits and feasibility of well thought out plans.
Small-business taxpayers face uncertainty from two directions: tax complexity and tax rates. As complexity increases, compliance costs rise and taxpayers become uncertain as to their total future tax burden. Moreover, complexity adds to the hurdles that small businesses must overcome. Rather than focusing on production and sales, small-business owners now must allocate much of their time toward bureaucratic record keeping and regulatory compliance.
Changes in rates from year to year add to the uncertainty, creating a deterrent effect on small firm hiring and investment. Clearly, complexity and uncertainty in the tax code are important issues for small businesses in particular.
Policy makers have traditionally concentrated on the tradeoff between efficiency and equity in constructing tax policy. The efficiency of a particular tax policy proposal is judged by whether it lets resources be put to their best possible use. Equity considerations strive to spread the tax burden as evenly as possible over the intended population. However, complexity (or its opposite, simplicity) is an equally important third leg of the tax policy framework, and it is often overlooked.
The cost of compliance-the number of hours spent on recordkeeping and form filling-is a measure of complexity. The lack of emphasis on simplicity in recent times has led to a bloated tax code where compliance costs have become a significant portion of many taxpayers’ overall tax burden, especially for small-business owners. The health of the small business sector, and the economy at large, will be improved by well-understood policies that promote simplicity and reduce complexity.
The Office of Advocacy is committed to tearing down hurdles that inhibit small business growth and entrepreneurship. Our office strives to make sure that America’s entrepreneurs can operate and prosper in an environment in which they fully understand their tax obligations and willingly comply, rather than having to concentrate on arcane rules and procedures. Such understanding, however, will not occur until tax simplification becomes a priority for policy makers at all levels of government.
Ray Marchiori is a regional advocate for the Office of Advocacy at the U.S. Small Business Administration. The Office of Advocacy is an independent voice for small business within the federal government. His service territory includes southeastern Wisconsin. For more information, visit www.sba.gov/advo.
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