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Fiscal blackmail - Lessons from behavioural economics can boost tax compliance

27 May 2014

Article from The Economist, May 24, 2014.

Jan-Emmanuel De Neve

PEOPLE go to great lengths to avoid paying tax. One popular trick in the Middle Ages was to become a monk; these days, shell companies in the Caribbean are a more common retreat. The gap between what is owed and what is paid is nearly $400 billion a year in America, and about £40 billion ($70 billion) in Britain. To keep the shortfall in check, governments design taxes to be tough to weasel out of. The value-added tax, for instance, allows firms to deduct tax paid on inputs from their sales-tax bill, in effect encouraging them to police their suppliers. Then there are the sticks: audits and penalties. Promising new research in behavioural economics could give governments another tool for boosting payment: the psychological nudge.

Economists have long understood that psychology matters in tax systems. Studies repeatedly find that tax gaps are much smaller than one would predict given the rarity of audits and the benefits of underpayment. Many taxpayers are motivated by more than just pecuniary concerns. Feelings of patriotism and civic duty ease the pain of paying tax (or make dodging less attractive). Guilt, or the perceived moral cost of violating social norms, also seems to enter the equation. It stands to reason that governments that exploit such emotions would save bundles of money in enforcement. They are already using such tactics to nudge people towards other desirable goals, such as saving energy or planning for retirement. Yet economists are only just beginning to test whether a similar approach could bring in more tax.

A recent working paper from America’s National Bureau of Economics Research documents experiments conducted by economists from Imperial College in London and the University of Chicago, with the British government. Whereas most Britons have their income taxes automatically deducted from their pay, a few with particularly high or complicated incomes file annual returns. Some of those who report that they owe tax are nonetheless slow to pay. Since they have already admitted their debt to the taxman, they are probably not trying to evade it. But the government must go through a time-consuming and expensive collection process to get what is owed.

That is where the economists come in. The authors conducted an experiment involving 100,000 taxpayers with overdue bills. They divided the sample into groups: one was sent a boilerplate request for payment; the others received letters with additional sentences designed to tug at the recipients’ heart- and purse-strings. One of the manipulative additions told the recipient what share of Britons pay their tax on time (about 90%). Another not only mentioned the share that pay on time but also pointed out that the delinquent was in the minority; a third noted that tax was vital for funding services like health care and roads.

© The Economist, May 24, 2014.

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