Simplifying the Tax Code Is a Pro-Growth Policy

The structure of a tax system shapes economic incentives, capital allocation and long-run growth. In the United States the federal tax code has evolved into a system defined less by clarity and neutrality than by complexity and distortion. The economic costs of this complexity are large, and they extend far beyond the taxes households and firms actually pay.

This article summarizes the main findings from a recent policy brief in which I examine the economic case for tax simplification in greater detail.

Compliance alone imposes a significant burden. In 2024, Americans spent an estimated 7.9 billion hours complying with federal tax filing requirements. This translates into roughly $413 billion in lost productivity, alongside an additional $133 billion in out-of-pocket compliance costs. In total, tax compliance costs approach $546 billion annually, or nearly 2% of GDP. These are real resources diverted away from productive activity.

But the costs of the tax code are not limited to compliance. Over time, the tax base has been narrowed through the expansion of deductions, credits, exemptions and exclusions, often together referred to as “tax expenditures.” These provisions function as implicit subsidies, favoring particular activities or industries. In doing so, they distort relative prices and redirect capital toward less productive uses.

Tax reform should not be evaluated solely in terms of statutory rates. The broader design of the tax base, and the incentives it creates, matter at least as much as do tax rates for economic performance.

Why Base Broadening Matters for Growth

Tax systems that broaden the base and reduce distortions tend to improve long-run economic outcomes.

Simulation-based studies of U.S. tax reform provide a useful starting point. Reforms that eliminate most deductions and credits while maintaining revenue neutrality are typically associated with sizable increases in output. These gains arise not from lower tax rates per se, but from improved incentives for work, saving and investment. When the tax system no longer favors specific activities, resources are reallocated toward their most productive uses.

Empirical evidence from real-world reforms reinforces this conclusion, with studies finding that such reforms raised annual growth rates during transition periods, primarily through increased investment.

Taken together, the literature suggests that reducing tax-induced distortions, especially those embedded in the tax base, can produce meaningful gains in economic performance.

The Hidden Costs of Complexity

Tax complexity imposes additional costs that are often less visible but equally important:

1. Complexity weakens perceptions of fairness. Survey evidence shows that many taxpayers view a complex tax system as inherently less equitable. When individuals believe that similarly situated taxpayers are treated differently, voluntary compliance declines, and incentives for evasion increase.

2. Complexity raises the cost of entrepreneurship. Navigating a complicated tax code requires time, expertise and resources that disproportionately affect small firms and new entrants. Empirical studies show that more complex tax systems are associated with lower rates of business formation and reduced economic dynamism. Even modest reductions in administrative burden can significantly increase the rate of new firm creation.

3. Complexity contributes to enforcement challenges. The U.S. tax gap (the difference between taxes owed and taxes paid) now approaches $700 billion annually. While multiple factors contribute to this gap, complexity makes accurate reporting more difficult and enforcement more costly.

In short, complexity is not merely an administrative inconvenience. It is a drag on economic efficiency, entrepreneurship and growth.

Investment, Capital and Growth

The most important channel through which tax simplification affects growth is investment.

Under the current system, savings and investment are often taxed multiple times. Income is taxed when earned and again when returns are realized, and while recent reforms have improved cost recovery, the tax code still falls short of full expensing in many cases. Together, these features raise the “user cost of capital”—the effective price firms face when investing.

A large body of empirical research finds that investment is highly responsive to changes in this user cost. Once methodological issues are addressed, estimates of the long-run elasticity of investment generally fall between −1 and −2. This implies that a 10% reduction in the cost of capital can increase investment by roughly 10-20%.

A simplified, consumption-based tax system, such as the Hall–Rabushka flat tax, would eliminate many distortions. By allowing full expensing and removing taxes on the normal return to capital, such a system would reduce the user cost of capital substantially.

The implications for growth are significant. A reduction in the user cost of capital on the order of 10% to 20% could increase the long-run capital stock by roughly 15% to 40%. Using standard production relationships, this translates into a GDP increase of approximately 8% over time.

Policy Implications

The case for tax simplification is often framed in terms of fairness, transparency or administrative ease. These are important considerations, but they understate the broader economic stakes.

A complex, distortionary tax system discourages investment, misallocates capital and suppresses entrepreneurship. A simpler system, one that broadens the base and treats saving and investment neutrally, can improve incentives across the economy.

Importantly, recent U.S. tax policy has already moved partially in this direction. The Tax Cuts and Jobs Act introduced full expensing for certain investments, reducing the tax penalty on capital formation. Evidence from the period when the statute was enacted shows that investment responded strongly to these changes, consistent with the broader empirical literature.

The One Big Beautiful Bill Act made these reforms permanent; however, they remain incomplete and uneven. A comprehensive approach to tax simplification would extend these principles across the tax code, eliminating many existing distortions.

Tax simplification should be understood not as a narrow administrative reform, but as a pro-growth policy. The current U.S. tax code imposes large compliance costs, embeds extensive distortions and raises the cost of investment. These features reduce economic efficiency and limit long-run growth.

By contrast, a simpler tax system, one that broadens the base and removes penalties on saving and investment, can generate substantial increases in capital formation and output. Even under conservative assumptions, the potential gains are economically meaningful.

A tax system that interferes less with economic decision-making is not only simpler, but more conducive to growth.