Taxes are explicit, so it is easy to sum them up. Total spending by government at all levels in the US is estimated at $6.41 trillion for 2010. [ 1 ] That’s about 44% of the gross domestic product. So that means that the private sector gets to choose how to spend the remaining 56% of the money, right? Not really. The government also requires us to comply with its rules, and the indirect costs are substantial. My partial list of indirect costs amounts to $1.8 trillion, more than 12% of the economy on top of the 46%.
The indirect costs of government regulation are sometimes an issue when legislation is proposed, but over time the indirect costs are assumed to be a necessary part of society. One of these implied costs surfaced in the new health care bill regulations requiring businesses to file a form 1099s. Perhaps $40 billion in accounting expenses will be suffered by business to collect to yield a claimed $20 billion in additional taxes.
The overall costs of tax preparation get attention, thanks to flat tax advocates. Estimates collected by the Government Accounting Office indicate that as of the mid-90s 2% to 5% of the GDP went to tax preparation. That’s 12% to 22% of the value of the taxes paid. The complexity of tax returns has risen since the 90s, so the current costs may be higher … or perhaps computers are coping better with the task, so possibly the costs have dropped. Typical of indirect costs, no one knows for sure. 2010 GDP is about $14.6 billion. The estimated cost of tax preparation is therefore likely to be in the range of $300 billion to $700 billion. We’ll say $500 for present purposes. By comparison, extending the Bush tax cuts is expected to cost about $280 billion next year.
There is a great variety of indirect costs beyond tax preparation.
Zoning and Building Regulations
The American with Disabilities Act is certainly well-intentioned, but because of the dangers of lawsuits filed under the Act, it reduced employment of the disabled from about 59% to 51% [ 2 ]. That is a cost to the disabled people. In addition, new building regulations were released in September. One community assessing the impact discovered that their swimming pool must have two handicapped entries, wheel chair lifts must replace some stairs, miniature golf course must be redesigned, fishing piers require handrails, and steam rooms must have wheel chair access. Those costs will get charged explicitly in local taxes, but the rules applied to business and residential construction will be reflected in higher prices.
Localities use zoning laws to, in effect, tax and transfer wealth. Doubling the required size for a lot to build a house lowers the value of undivided land. A double-sized lot is worth only a little more than the single-size. The owner of the undivided land loses, while the owners of developed lots gain, because there will be less housing available in the market. Overall, the price of of real estate increases due to decreased supply, and homeowners will ultimately pay that cost in terms of less affordable housing.
Zoning laws also sterilize land to “preserve” the natural beauty. Land owners are essentially taxed individually to provide for open spaces, rather than having the town buy the development rights at market rates. Since zoning changes affect wealth, many property owners pay to apply for exemptions and to curry favor with politicians who can grant them.
If one has the correct zoning, the next step is to obtain a building permit. Building permits impose elaborate regulations on what can be constructed on the site and how it is designed. It takes an expert on the rules to make a compliant design, and even with an expert, there is often haggling with compliance issues. Costs accrue from additional design time, the costs of adding features not wanted by the owner, and opportunity cost of having a project delayed. One study [ 3 ] put the costs due to building permit delays alone at about 20% over five years. The bulk of costs, however, are in making the design compliant.
The October, total construction in the U.S. was running at the rate of about $800 billion per year. It’s just my guess that a quarter of those costs are due to the permitting process. It’s even more speculative as to the extra costs due to zoning requirements, but I’m guessing a like sum. A ballpark figure for the indirect costs of both is $400 billion.
Minimum wage laws have no effect if the free market labor rates are above the set minimum. When they do boost salaries, the effect is to effectively tax the business to provide welfare to the worker. The costs are ultimately born by the consumers of the products. 3.5 million workers receive the minimum wage. If the average wage is increased by $1.50, the cost is about $11 billion.
Costs imposed on government-regulated utilities can be staggering. So-called “green” energy is about four times the cost of conventional generation. The US consumed 4,119 million MWh in 2008, the most recent data available. [ 4 ]. Residential electricity is about 12 cents per KWh. Industrial use is probably cheaper overall, but that will get us in the ball park. That would be $120 per MWh, or about $500 billion worth of electricity. So going entirely to green power would impose an indirect cost of about $1.5 trillion per year. Recall that the total taxes collected is $2.1 trillion. We are not going to convert to 100% green power any time soon, but suppose we took the modest step of 20% green. That’s $300 billion in extra costs.
The government mandates that corn-based ethanol be blended into gasoline, with increasing amounts over the next decade. Energy from corn ethanol cost more than five times that of gasoline. [ 5 ] The extra cost is now covered by subsidy, now totaling over $4 per gallon. [ 6 ] The indirect costs lie in the increased price of corn and of other grains. Prices of other grains rise as land is transferred to corn production. Increased grain prices also result in increased prices for beef and other grain fed meats.
Food prices are rising, but it’s hard to quantify the effect of the corn diversion to ethanol. Home food prices rose by only 1.7% in the past year, amounting to about $20 billion. Let’s guess half of that was due to the ethanol mandate. That’s not much on the scale of GDP, but stay tuned in future years.
Ethanol decreases gas mileage. Used in E85, the standard blend with 15% ethanol, the theoretical minimum loss is a little under 5%. Consumer Reports measured an SUV that lost 27% on E85. Losing more than 15% means that something is interfering with recovering energy from the gasoline component. The 2010 requirement is to produce 12 billion gallons of ethanol, which would make 14.1 billion gallons of E85 costing about $40 billion at the pump. A 5% mileage loss implies a $2 billion cost, 27% would be $11 billion.
The individual mandate to buy health insurance is currently under constitutional challenge. It wasn’t count as a tax in figuring the costs of the legislation, but the government is now arguing it is a tax. We’ll have to see if ends up as an indirect cost. Right now, however, the economics of Medicare and Medicaid depend upon overcharging those not covered by the government to subsidize clients. Advocates say that “efficient” suppliers of health care can live within the payments allowed. The Mayo clinics, with a staff of 3700 physicians and having been cited for its efficiency by President Obama, stopped accepting Medicare patients at its Facility in Glendale, Arizona at the end of 2009, claiming that the government payments covered only 50% of the costs.
Nationwide doctors make about 20 percent less treating Medicare patients. [ 7 ] Average health costs are $8700 per person in the US, and there are 45 million people under Medicare. Twenty percent implies $78 billion extra paid by the private sector to fulfill the benefit.
There are about 50 million people receiving Medicaid from the states. Fewer doctors are accepting new Medicaid patients than are accepting new Medicare patients, so it’s safe to assume that the reimbursement percentages are worse. I’ll say $100 billion for present purposes.
The US has a unique system of lawsuits. One study put the total cost of the tort liability system at $865 billion, of which less than 15% goes to compensating injured people. [ 8} ] I assume that includes the costs of the Court system covered directly by taxes, but that most of the costs beyond the awards lie with the lawyers. Many countries have a “winner pays all” system that discourages the filing of lawsuits, but I could not find an estimate of how much a change in the US tort liability system would save. Let’s guess $400 billion. The excessive costs are covered by liability insurance premiums, which means they are passed along to consumers in the costs of products and services.
The Bottom Line
I am not arguing that all indirect costs are a waste. Having a house in Florida built to meet requirements spawned by hurricanes may save money in the long run. Fire safety laws result in fewer fires, and that saves lives and rebuilding. Laws against pollution produce indirect savings in health care and clean up. The point is that government is making decisions with cost consequences, and we ought to decide how much of that we want.
My estimates of indirect costs of government add to about $1.8 trillion, and I’ve left things out. There are costs of complying with environmental regulations and safety regulations, costs of lost opportunities (as with prohibited oil drilling), and costs for qualifying to obtain licensing for anything the government licenses. If it’s only $1.8 trillion, the total burden due to government is 56.2% of GDP.
The non-government sector of the economy supports the government sector, so it’s critical how much money is available for productive investment. My list is both incomplete and full of guesses. Someone, perhaps a think tank, should do a careful job of assessing indirect costs. As political pressure to cut government spending builds, we can expect government will find more creative ways to impose it’s will through indirect costs, as it has done with green energy. Accountability should not stop with taxes.