PLANK JUNE 7, 2012
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Is the American public's distaste for taxation irrational? A 2011 paper by Abigail B. Sussman, a graduate student in psychology at Princeton, and Christopher Y. Olivola, a fellow in behavioral science at the University of Warwick, suggests that it is. The paper, published last year in the Journal of Marketing Research (and flagged today by the Russell Sage Foundation's Twitter feed) found that between two ways to save money--(legal) tax avoidance or straight-up discount--more people will choose the former than the latter, even when the latter saves an equal or even greater amount of money. There's just something about not paying taxes.
Sussman and Olivola detail this phenomenon by describing three experiments.
Experiment One. One set of respondents is presented with this hypothetical:
You want to buy a new television and have a particular model in mind. Calling around, you find that only two stores, Bob’s Electronics and Tom’s Electronics, carry that model. Bob’s Electronics is located very close, about a 5-minute drive, but offers no discounts on the television set. Tom’s Electronics is located farther away, about a 30-minute drive, but offers the television set [tax-free, which is equivalent to an 8 percent discount] Where do you go to make your purchase?
A second set of respondents is presented with a near-identical hypothetical. The only difference is that instead of offering an 8 percent discount through tax avoidance, Tom's Electronics offers a 9 percent discount through an in-store markdown.
Unsurprisingly, a majority of both respondents said they'd bypass Bob's and drive 25 minutes further to Tom's to get a discount. But a lot more said they'd go to Tom's for an 8 percent discount attributable to the TV set not being taxable (76 percent) than said they'd go to Tom's for a 9 percent discount directly from the seller (59 percent). The no-tax inducement was significantly more effective than the (larger!) markdown inducement.
Well, some people get suspicious when they hear a store has marked something down. Maybe that means it's a floor model into which small children have poured sticky fruit juice. That brings us to ...
Experiment Two. New hypothetical. The first set of respondents is asked:
Imagine that you are walking through the mall looking for a particular jacket that you have seen advertised. You come across two closely located stores that carry it. The first store offers no discounts, but has no wait to purchase the coat. The second store is having a special [“axe-the-tax” sale, with the store selling all items tax-free, equivalent to a 9 percent discount]. However, due to the popularity of the sale, there is a wait to purchase items there. How long would you wait in line to receive the discount?
A second set of respondents is presented with a hypothetical that's identical except that instead of a tax-free discount that saves 9 percent on the coat, the discounting store offers a "customer rewards" sale that discounts all items in the store--not just the coat--by the same 9 percent. Then both set of respondents are presented with a variation on each of their hypotheticals asking not how long they'd wait in line to receive a 9 percent discount, but rather, how deep the discount would have to be to persuade them to wait 15 minutes.
In both instances, the 9 percent discount attributable to a tax exclusion was deemed more compelling than the 9 percent discount attributable to a store-wide sale. The tax avoiders were willing to wait longer, on average, for their 9 percent discount (32 minutes), than the customer-rewards-seekers (26 minutes). Similarly, the tax avoiders required a smaller discount to wait 15 minutes (6.7 percent) than the customer-rewards-seekers (7.3 percent).
Well, people aren't necessarily very smart about how they purchase consumer goods. They're probably smarter when it comes to making investments. That brings us to ...
Experiment Three. The first set of respondents is asked whether they prefer to invest an inheritance in their bank account or in a corporate bond. The bank investment carries no risk and pays $75 per year in interest (after $25 in taxes is removed). The bond investment carries some risk and requires that the principal not be withdrawn for 10 years, but it will pay $120 per year (after $40 in taxes is removed).
The second set of respondents is asked to respond to a hypothetical that's identical, except this time the bond is a municipal bond, not a corporate one, and therefore is not subject to taxation. In spite of that difference, the net annual interest from the bond remains an identical $120.
This time the disparity was huge. Eighty-two percent of the tax avoiders chose the risky $120 interest from the municipal bond investment over the non-risky $75 interest from the bank investment. But only 18 percent of the non-tax-avoiders chose the corporate bond investment, even though the difference was the same $45.
Well, maybe a government-bank bond seems less risky than a corporate bond. That brings us to ...
Variation On Experiment Three. This time there is only one pool of respondents. It is given a choice between two bonds, which are not identified by type at all. Both bonds have the same risk and both require the principal not be withdrawn for 10 years. One bond pays $400 per year in interest, on which $100 is removed for taxes. The other bond pays $300 per year in interest and is tax-free. Want to guess how many preferred the tax-free bond, even though it netted precisely the same amount? Seventy-seven percent! People would much rather make $300 per year knowing they aren't contributing anything to the government than make $300 per year after taxes. It makes no financial difference to them, and a $100 difference to the Treasury. They hate paying taxes so much that they'd rather deprive the government of revenue than not, even when there's no benefit to themselves.
This, apparently, explains Grover Norquist's existence. Norquist, I suppose, would dispute that this behavior is irrational. He would likely say that people's wish to see the government shrink is entirely divorced from financial self-interest. They aren't cheapskates, they just hate big government. But of course poll after poll shows that people don't want the government to shrink--not when "the government" is described to them not as an abstraction but as specific government programs. What people want is big government that they don't have to pay for.
10 comments
Okay, folks don't like to pay taxes, but words carry a powerful message. That "tax free" bond that pays the same after tax interest as the taxable bond is more attractive because it's "tax free"; don't you suspect that most folks have no idea whether repayment of the principal on that "taxable" bond is taxed, but they "know" that repayment of the principal of the "tax free" bond is not taxable. These types of polls say a lot about ignorance but little about anything else. After all, about 80% of working Americans pay more in payroll tax than income tax, and yet if polled they would no doubt credit Republicans for "cutting" their taxes even though Republicans never cut payroll taxes.
- rayward
June 7, 2012 at 6:28pm
We were a country born in rebellion, after all. We continue to rebel.
- liberalref
June 7, 2012 at 9:07pm
Sorry, I don't buy this. If I call a store I ask what the final price is, if one store says no tax but is higher than the other I would ask the first store how much it is with the tax, and if it is cheaper and closer there is no way in hell I would drive. This hypothetical doesn't factor in the unwillingness of most Americans not to sit in traffic for half an hour to pay more. A hypothetical half hour is a hell of a lot shorter one that a real half an hour. As to experiment two, it depends on how long the wait is, and if one store offered discounts with no wait I would jump for that. I hate waiting, it is like a little death. I know of few men who would wait 15 minutes in a long line to buy an article of clothing unless the check out girl was unbelievably hot and topless. As to experiment 3, that tax rate is ridiculous so I would have no faith in it. But I would also know that a tax free bond supports local or state government. A far better scenario is to actually make participants do the hypothetical. By the way, I put my retirement money into Roth IRA's, which means I pay the tax on the income up front but don't have to pay it on retirement. Does this mean I love to pay taxes now and hate to pay them later? Of course not, I do it because the math is right. So I call bullshit on this study.
- blackton
June 7, 2012 at 11:11pm
The psychological literature on irrational choices is immense. I doubt that this has much to do with government as such. I would bet, for instance, you would get similar results from the following: The TV sells at Bob's for $300; it sells at Tom's for $250, but at Tom's you have to pay with a credit card that charges a $50 surcharge. It's a question of fairness; you would rather give the whole $300 to Bob, who is providing you a TV, than give $50 of it to the credit card company, which is doing nothing. Same thing with the govt.
- ErnestDavis
June 7, 2012 at 11:29pm
As regards the final variant, one would naturally suppose that the bond that pays $300 has lower risk than the bond that pays $400, even if the experimenter has stated otherwise. And the description, "They hate paying taxes so much that they'd rather deprive the government of revenue than not, even when there's no benefit to themselves," misses part of the point. After all the money going to the government is coming from _somewhere_, namely the anonymous bond-issuer. So all you can say is that the subjects prefer that the $100 stayed with the bond-issuer rather than get paid to the government. Why is that irrational? Put it another way: Suppose people were asked "You get to decide whether $100 will be transferred from some unnamed organization to the government or not." Why would it be rational for them to decide that that would be a good thing?
- ErnestDavis
June 7, 2012 at 11:52pm
Or a better example, because more plausible. You have a choice between buying a bond that pays $300, or buying a bond that pays $400, but must be purchased through a broker who charges a $100 brokerage fee. I'll bet most people would go for the first. -- Ernie
- ErnestDavis
June 8, 2012 at 12:06am
"The psychological literature on irrational choices is immense." - ErnestDavis Yes. But many "irrational" errors are actually misunderstandings of "basic" math, such as the difference between percentages and percentage points; or between relative and absolute values (that pesky $45); and the monetization of time ("life-hours," or assigning dollars to lengthy activities, such as waiting for a sale, to determine their worth). Consumer math can be tricky at first, but so are other competencies expected of adults (grammar, driving, etc.). Count on it: Tax obsessives leverage math misunderstandings into "starve the beast" policies, so widespread innumeracy contributes to their political success.
- Wonderland
June 8, 2012 at 8:40am
There was an expression years ago when the top tax rate was 50%. "The first thing a businesman does is gets rid of his 50% partner." That's what we call the tax tail wagging the dog.
- Nusholtz
June 8, 2012 at 12:14pm
Interesting. So the Fox-News Republican anti-Tax propaganda message has become mainstream. Most people now hate taxes so bad, they'll shoot themselves in the foot (by lowering tax-rates of wealthy people, reducing services for themselves) rather than agree to pay taxes. I guess, if you say "It's YOUR Money!" often enough, enough people believe it to warp intelligent tax policy into "No taxes, no matter what". That does explain how the Tea-Party arose (with Fox News Sponsorship) opposing "high-taxes" at a time of historically LOW tax rates. It's simply not a rational point of view.
- AllanL5
June 8, 2012 at 12:16pm
rayward writes: "n payroll tax than income tax, and yet if polled they would no doubt credit Republicans for "cutting" their taxes even though Republicans never cut payroll taxes." Ah, but they did. The middle 20% paid 5-6 pre-Bush II, and around 2% during Bush II. Government has a massive perception problem. Nobody can readily see the benefit they are getting. And those that are getting an in-your-face benefit, such as medicare, believe they are entitled to more than they are getting, and are clueless to the fact that they are underpaying the value of what they are getting. That is what makes it unsustainable. But it also highlights just how poor of a value judge people are. I think people like paying local taxes. They love seeing things built in their city that they voted for in a bond. They love getting together and lobbying for a stretch of road to be re-paved in their town. Of a bridge to be painted. This is government in is purest and most healthy form. I vote yes on just about every local tax issue that comes up because the results are immediate, impactful, and I know it's gone through minimal filtering (and thus waste). The way taxes flow today are incredibly wasteful. The country spends $300B preparing their taxes (10% of what the government takes in in a year) and then the big pot of money flows through countless filters, and each time a bit is skimmed off the top. By the time it makes it to my local, I had to earn $1.30 to get $0.60 for a new bridge. No thanks. Let's keep it more local. My guess is that when asked about corporate bonds, tax free munis, etc, most people had no clue what was being talked about. And if they do know, most prefer the broader stock market to tax-free bonds anyway for their 401K selections. And historically, as young investors, they probably are right.
- seattleeng
June 8, 2012 at 12:59pm