Our nation and our state face enormous fiscal challenges ahead. The very essence of what government’s role should be is being questioned during these difficult economic times. Our nation is undergoing one of the most severe economic dislocations since the Great Depression and in the course of propping up the economy; the federal government has accumulated tremendous deficits. Moreover, many states have gotten used to the tax revenues generated from the pre-recession period but have yet to wean themselves off the spending patterns that grew to absorb those tax revenues. Many states find themselves with immense unfunded of underfunded pension and healthcare obligations. In some instances these obligations dwarf the current expenditures on the current employees in those agencies. Unfortunately, our nation’s and many states’ elected officials have refused to address these issues, preferring to “kick the can down the road”, or at least have attempted to delay until they are out of office. So our nation and states now stand at a crossroads in terms of our fiscal health and must ask the questions “to tax or to cut”.

While spending cuts and tax cuts seem to be very popular with those who believe that the government is already too large and needs to be scaled back significantly, the challenge will be to arrive at a political solution to this problem. However, the problem runs deeper than simply cutting taxes or spending. Our tax structure is highly inefficient, not in the sense that funds are lost or that there are too many tax collectors, but in the sense that the tax system encourages behavior that would not otherwise occur.

According to the Tax Foundation, Americans spend nearly 20 cents for every dollar collected in taxes on tax compliance. This tax compliance includes completing tax forms, seeking tax planning and filling out other paperwork.   According to the CATO institute, the cost of tax compliance is nearly 2 percent of Gross Domestic Product, or roughly $265 billion.

The complexity of the tax code not only interferes with economic planning, but has also fostered an entire industry segment that has devoted itself to assisting firms and individuals in aggressively avoiding taxes.

Moreover, due to the complex nature of the tax codes, these firms are able to exploit the loopholes which in turn push Congress to act to close those loopholes, which then creates more loopholes and the cycle goes on.

While our tax system is highly complex, the way government spends and allocates funds to achieve its goals is much more complex and perhaps inefficient. A recent Government Accounting Office (GAO) report finds that numerous federal agencies perform similar if not duplicative duties and have identical programs. According to the report, there are nearly three dozen agencies and sub-agencies in which there are duplicate and/or fragmented programs.  The agencies range from agriculture to defense to social services.  While many elected officials are bemoaning the excessive waste that is inherent in the federal government, the fact of the matter is that the report indicates that $100 billion to $200 billion is duplicative spending. Out of a $3.4 trillion budget, this duplicative spending amounts to less than 1 percent of the total budget.

It is clear the current tax system is a drag on the economy. Perhaps more tax revenue could be collected with a simplified tax code. In addition, how funds and programs are disbursed within the federal government can be characterized as inefficient. However, many elected officials want to avoid addressing these problems and go directly to cutting programs and cutting taxes as to avoid upsetting their constituencies. One of the roles of economists is to assist society in identifying efficient allocations of scarce resources among various competing interests. From this economist’s point of view, our current tax system and the waste within government needs be addressed before we decide to change our taxes or spending.