Up For Discussion

Taxes Hurt So Good

Levies Can Be Painful. But the Right Ones Bring Big Gains


Life has only one certainty other than death: taxes. And taxes may be less popular than death in 21st century America. Much of today’s politics is centered on opposition to taxes.

So what is the point of taxes? More than just securing money for the government. Taxes are often meant to promote good behavior. But are taxes an effective way of getting people to do something they otherwise would not do? And should we be using taxes this way? In advance of economist Robert H. Frank’s visit to Zócalo to ask, “Did Darwin Create Modern Economics?”, we checked in with some experts in tax policies about their thoughts.

Taxes Improve Incentives

Of course taxes can promote good behavior. This need not involve inspiring taxpayers to do good as an end in itself. But if we care about results, not psychological motivations, then taxes can promote socially good rather than bad activity by two mechanisms. The first is improving incentives. The second is encouraging people to feel that acting legally and honorably makes sense.

Consider pollution taxes. Suppose a factory owner could spend $90 producing goods for which consumers would pay $100. All else equal, we might think of this as producing social surplus of $10. But suppose the production would create pollution that ought to be disvalued at $15. Now the production is undesirable, since the $105 social cost exceeds the $100 benefit. If we impose a properly measured and enforced pollution tax of $15, the production presumably will not take place. So the tax induces “good” rather than “bad” behavior, even though the factory owner is no more benevolent at heart in the world with the pollution tax than in the world without it.

Next, consider what tax aficionados call the “audit lottery.” Suppose an aggressive tax-planning scheme permitting me to reduce my reported income tax liability by $100 has only a 20-percent chance of being legally valid. If I were audited and lost, I might have to pay not only the $100 but also a modest tax penalty. (Jail for outright tax fraud is highly unlikely.) Now suppose as well, very realistically, that I face only a 5 percent chance of being audited. This causes the scheme to offer a positive expected payoff. Aggressive gambling on non-detection can therefore become quite widespread if people are simply calculating the odds in a low-audit environment.

Empirical studies find, however that, so long as people think the tax system is reasonably fair, and is generally being complied with by most others, aggressive “audit lottery” participation tends to be surprisingly low. So taxes can contribute to broader social cooperation through their impact on attitudes–although I still think higher tax penalties or audit rates would help.

Daniel Shaviro is Wayne Perry Professor of Taxation at New York University School of Law.


Taxes Are the Road to Virtue

Everybody would rather have more money than less, and so we naturally groan on tax day. But we can also step back for a moment from the immediate pain of filing the forms and writing our checks. And when we take a slightly broader view, it’s easy to see that paying taxes is good for us, in at least three ways.

First, taxes encourage individual virtues. The Earned Income Tax Credit encourages work. Another example is much more ambitious. A carbon tax–by making people pay the full and true costs of using fossil fuels and at the same time reducing the tax burden on other activities and investments–would perhaps do more to save the planet, and with it our species, than any other public policy.

A second benefit to paying taxes is more general. No less than Oliver Wendell Holmes once said, “I like to pay taxes. With them I buy civilization.” Holmes’s remark emphasizes that taxes pay for many good things, including the provision of public virtues. Although it is fashionable to say that government is at best wasteful and at worst corrupt, government is in fact an incredibly good deal for most Americans. An American family of four, earning a total income of $75,000, might pay about $10,000 in federal income and payroll taxes. For that it gets benefits like national defense, interstate highways, Social Security, Medicare, and consumer protection. Taxes also enable government to sustain civic virtues, such as historic and environmental conservation, public education, civil rights, and the rule of law. The same family might easily pay its cable company $1500 and get only cable TV.

Third, and most profoundly, we don’t just buy civilization by paying taxes to someone else; we make civilization by paying taxes to ourselves. When we say that we are Americans, we mean that all American citizens–past, present, and future–belong to a collective project. We aspire, in the words of our Constitution, to “establish justice, insure domestic tranquility, provide for the common defense, promote the general welfare, and secure the blessings of liberty to ourselves and our posterity,” all in order to “to form a more perfect union.” We cannot do these things or achieve their purpose alone or costlessly. Instead, they require shared sacrifice–given for and to one another. And when we recognize that by sharing in this way, we become a more perfectly united people, the sacrifice no longer seems so large.

Daniel Markovits is the Guido Calabresi Professor of Law at Yale Law School.


Make It Easier to Be Good

Good for whom? The individual? The family? The community? The environment? The economy? These are immensely difficult questions because conflicts inevitably arise between different constituents, and tradeoffs must be made.

Where should we be looking for answers? Robert Frank and other economists are beginning to look to Darwin for insights–in particular, the Darwinian focus on individual self-interest. Self-interest has long been the key to economic thinking as well. But whereas Adam Smith and other economic thinkers believed that economic order and prosperity were the group-level products of unbridled self-interest among individuals–ideas that are now being called into serious question–Darwin had little to say about group-level processes. Indeed, apart from some broad generalizations about mental continuity between humans and other animals, Darwin had little to say about how evolutionary principles might apply to human behavior at all, let alone human behavior in a modern market economy.

How could he? There was little in the way of a behavioral science at that time. Things are quite different today, of course. We now have rich and rapidly growing disciplines devoted to understanding behavior from an evolutionary perspective. And it is to this field that we should be looking for answers to the question about whether taxes can promote good behavior.

What does this science tell us? Well, for one thing, it tells us that people are notoriously bad at balancing longer-term against more immediate outcomes. To take one example, people frequently make poor dietary choices, despite clear and compelling evidence of the long-term detrimental consequences of such choices. This is understandable in evolutionary terms. At one time in our evolutionary past, gorging on foods high in sugar and fat were important to survival-enabling our ancestors to withstand food shortages. Eating–and frankly, overeating–emerged as an adaptive form of behavior. Things are quite different for most of us today. We now have abundant food sources, and the overconsumption of fatty foods, once adaptive, is now among the most serious health issues facing our culture. We need to supplant our short-sighted self with one that also takes our future self into account.

Promising in this regard is research showing that dietary choices respond to incentives (and disincentives) that can act to override immediate self-interested actions. Recent research has shown, for example, that consumption of sugar-sweetened soft drinks is strongly affected by taxes (the same is true for alcohol and tobacco). Consumption of such substances decreases and is partially replaced by healthier items. Taxes on such items are politically popular, especially when the revenues are put back into obesity and substance-abuse programs. This suggests that such incentive programs reflect the collective values of the group–an important ingredient in adoption and long-term success.

Now, some may object that such programs are paternalistic in removing an individual’s autonomy and personal responsibility. But in developing programs that help people make good choices, we no more remove personal responsibility than when we require kids to attend school, or drivers to stop at red lights, or citizens to pay taxes to build schools and roads. We have always had rules and regulations that temper unbridled self-interest. The real question is not whether to intervene, but rather, when we do so, whether we should continue to rely on intuition and conventional wisdom (as in the past) or use what is known about human behavior from a modern scientific perspective.

What this emerging science tells us, in part, is that social and economic programs are far more likely to succeed if they bring what is good for the individual in the short run into alignment with what is good for the individual and the group in the long run. By easing conflicts between immediate and longer-term gains, such programs make it easy to be good–a kind of enlightened self-interest. Now, that is true Darwinian thinking, but updated to reflect the social and economic conditions of our time.

Timothy Hackenberg is professor of psychology at Reed College. He recently organized a conference called “Behavioral Economics: From Demand Curves to Public Policy,” and is editing the proceedings for an upcoming issue of the Journal of the Experimental Analysis of Behavior.


Taxes Should Be Neutral And Shouldn’t Affect Behavior

Taxes affect our behavior in many ways. If you have been frustrated by the act of preparing your income tax returns, you know taxes affect your behavior. Recall that frustration with taxes and the government imposing them led the colonists to dump tea in the Boston Harbor in 1773.

From an economic perspective, taxes affect behavior, because taxes involve money and everyday activities, such as working and shopping. In this context, some tax rules are purposely designed to lead people or businesses to do something. For example, a tax credit might be offered to businesses for hiring unemployed workers or to individuals for buying a hybrid car. Tax penalties, such as for failure to file, encourage people to comply with tax rules.

Taxes can discourage undesired behavior. “Sin taxes” such as excise taxes on alcohol and tobacco, not only raise some revenue, but are intended to discourage certain activities, such as smoking by teenagers. Chicago’s Bottled Water Tax aims to encourage greater use of tap water to help the city cover its costs of producing it.

Despite the natural effect of taxes (money) on behavior, principles of good tax policy suggest that taxes should be neutral and not affect decision-making. Lawmakers frequently violate this neutrality principle because of the powerful effect taxes can have on helping to reach a jurisdiction’s economic, societal, and environmental goals. The tax system is often the go-to tool for attempting to reach any number of desired outcomes, such as more open space, healthier lifestyles, or greater energy efficiency. While tax rules may help change behavior to get a desired result, it comes at a price of a more complicated tax system (more forms and rules) and greater inequities (tax breaks for some are paid for by others).

So, are we swayed by taxes? Most definitely. Should we continue to build more behavior–changing provisions into our tax system? Probably not.

Annette Nellen is a professor in the department of accounting and finance at San José State University, where she teaches graduate-level tax courses. She maintains the 21st Century Taxation website and blog.

*Photo courtesy of Images_of_Money.