🔢 Key Takeaways
- People are willing to give money to the government if they support its cause, and the tendency to be altruistic increases with a specific purpose. Providing a clear purpose can result in greater giving.
- Allowing taxpayers to donate their tax dollars for specific purposes, such as disaster relief, could increase compliance and reduce the U.S. tax gap. A market mechanism could further enhance this approach, ultimately encouraging greater generosity and civic engagement among Americans.
- Tax policies affect important life choices such as marriage, having children, and even death. Tax noncompliance rates differ between individuals and employees with automatic tax withholding. While incentives may not work, tax policy plays a vital role in shaping society.
- Failing to comply with tax regulations can result in tax evasion, which is responsible for a significant portion of the tax gap. While tax avoidance is legal, tax compliance is crucial to avoid consequences for not reporting income properly.
- Taxes have always prompted innovative ways to avoid or evade them. Wealth taxes in Europe didn't generate much revenue but caused wealthy individuals to leave the country. Despite enforcement advantages, inventive tax evasion will persist.
- Providing incentives, implementing penalties and audits, building trust, and leveraging social pressures are all effective ways to increase tax compliance.
- Giving taxpayers the ability to allocate their taxes to specific causes they support can improve compliance and increase donations. Providing accessible data can improve trust and give people a sense of control over their taxes.
- By allowing taxpayers to allocate 10% of their taxes to specific categories, compliance could increase by 15%. Participatory budgeting could be implemented on a federal level without radically realigning the budget.
- Urbanization is leaving rural areas with aging populations and depleted tax bases. Japan's hometown tax system incentivizes citizens to donate to their hometowns, supporting local infrastructure and services.
- Japan's hometown tax system allows citizens to buy regional products that are tax-deductible from national tax, fostering competition among different regions and creating entrepreneurial spirits, but the program is criticized for favoring higher-income households.
- The hometown tax system is a successful means of tax deductibility and helps rural areas in Japan attract funding for specific causes, but its regulations require extra caution to distribute funds equally and avoid abuse by local governments.
- Incentives can be effective in promoting certain behaviors, but over-reliance on them can erode trust and compliance. Any new system must carefully balance incentives with maintaining a sustainable and fair system.
- Learning about government processes, such as tax allocation, can initially lead to frustration but ultimately improve citizens' relationships with the government. Dialogue and accountability introduced by agencies can lead to greater understanding and encourage government transparency.
📝 Podcast Notes
The Power of Altruism and a Compelling Reason
Economist Catherine Eckel's experiment on dictator games showed that people are willing to give money to the government if they support its cause. This contradicts the belief that people won't voluntarily give money to the government. The experiment also revealed that people have a tendency to be altruistic, which increases when there's a compelling reason or a specific cause. Receiving scrutiny from professors could influence a participant's behavior and skew results, as evidenced by economist John List's argument. Eckel's experiment substituted an anonymous person with the American Red Cross, and the participants gave significantly more to the latter. The experiment shows that a concrete purpose results in greater giving.
The Benefits of Earmarking Tax Dollars for Specific Purposes
Allowing people to earmark their tax dollars for specific purposes, such as disaster relief, could increase tax compliance and bridge the U.S. tax gap. Research has shown that people are willing to donate almost as much to a government organization as they would to a private one, so giving taxpayers a choice in where their money goes could incentivize compliance. This concept could be further enhanced by creating a market mechanism, where citizens can compete to support their preferred causes. The U.S. tax gap, which is currently at around 15 to 20 percent of the total amount due, could be significantly reduced if taxpayers had a say in where their money goes. Overall, this innovative approach could encourage greater generosity and civic engagement among Americans.
The Impact of Tax Policies on Decisions and Behaviors
Tax policy impacts many aspects of people's lives, including decisions such as marriage, having children, and even death. Some individuals go to great lengths to avoid paying taxes, with an estimated 16% of federal taxes not being remitted. However, for employees with wages and salaries, the noncompliance rate is only around 1% due to automatic tax withholding. While offering incentives such as gifts for tax donations may not have a significant impact on compliance, tax policy remains a crucial and pervasive aspect of society that affects countless decisions and behaviors.
The Importance of Tax Compliance for Self-Employment and Business Partnerships
Self-employment income and business partnerships tend to be fairly opaque, leading to a real temptation to lower the income reported to the IRS. Without third-party reporting, people are more likely to engage in tax evasion, which is responsible for about 80% of the nearly half-trillion-dollar tax gap. However, tax evasion is not the same as tax avoidance, which are legal ways to reduce your taxes. Taxation has been perhaps the most powerful tool that a government can wield, with countless rebellions and revolutions driven by tax issues. Tax avoidance and evasion have been around since ancient times, with records dating back to the 7th century B.C.E. This highlights the importance of tax compliance and the implications of failing to do so.
Creative Solutions of Tax Avoidance and Evasion Throughout History
Throughout history, taxes have led to creative solutions of avoidance and evasion. The window tax in England resulted in some houses bricking up windows or installing windows that allowed light into two rooms. Similarly, the bachelor tax led to the emergence of professional lady rejectors who for a fee, filled out forms saying that the person had proposed to them and been rejected. With talk of new wealth taxes in the US, it's worth noting that wealth taxes in Europe have had low revenue and led to wealthy individuals leaving the country. While the US has some advantages in enforcing tax reporting, creative solutions to avoid taxes will likely continue.
Strategies for improving tax compliance
Increasing tax compliance is a challenge despite people agreeing that paying taxes is their civic duty. Correspondence from the government tends to increase compliance, as people realize the government knows they exist. While incentives like carrots or sticks work, evidence suggests that sticks work better, as seen in the fear of audits. However, the budget cuts in the IRS have impacted their stick as penalties for failing to pay taxes are not severe enough. Social pressure also plays a role in compliance, as people tend to pay if they see others paying. Trust in the government is crucial, and people tend to comply if they feel the government is trustworthy. Overall, increasing compliance requires a combination of incentives and social and government pressure.
Allowing Taxpayers to Choose Where Their Money Goes
Allowing taxpayers to allocate their tax dollars towards specific causes they support can significantly increase compliance and donation amounts. Studies show that people are twice as likely to give to a specific cause than a general fund and donate roughly two and a half times more. Paying taxes can be an unpleasant task, especially when the benefits are diffuse and the cost looks bigger. Making the data accessible, such as through a website that allows taxpayers to allocate their tax dollars across a pie chart, can address both recoupling and agency. Allowing people to express their opinions about how their taxes are spent can change tax compliance. However, lab studies may not accurately reflect real-world responses.
Allowing Taxpayers to Allocate Their Tax Dollars
Allowing taxpayers to allocate a portion of their tax dollars to specific categories could increase compliance by up to 15 percent, according to a study by Lamberton. However, the challenge is that the spending a taxpayer may prefer is not always the government's priority. By allowing taxpayers to allocate just 10 percent of their total tax bill, Lamberton suggests a compromise that would maintain funding for essential projects while providing taxpayers with agency. Participatory budgeting, already tried by local governments, could work on the federal level, and the federal tax form could serve as a mechanism to implement it. Evidence from Lamberton's research shows that participatory budgeting would not cause a radical realignment of the federal budget.
The Japanese Economy and Rural Imbalance
The Japanese economy is enviable due to its ability to balance multiple outcomes, including economic freedom, equity, and growth. However, structural issues persist as the economy is heavily concentrated in a few megacities, leaving the rest of the country in deficit and relying on significant redistribution efforts. This imbalance is not unique to Japan and is also happening in other countries, including the U.S., as urbanization increases. The trend of young people leaving rural areas for cities is leaving hometowns with aging populations and depleted tax bases. One potential solution is Japan's hometown tax system, which incentivizes citizens to donate to their hometowns, increasing tax payments and supporting local infrastructure and services.
The Success of Japan's Hometown Tax System
Japan's hometown tax system, furusato nozei, has been successful in creating a market mechanism that allows citizens to choose regional products they want to buy. These products are tax-deductible from national tax, inspiring competition among different villages and regions and creating entrepreneurial spirits. Catalogs of goods are available based on different prefectures and villages to enable citizens to select their products. The system has been successful, with more than four and a half billion U.S. dollars in hometown tax donations in 2018. However, the program is criticized for favoring higher-income households, and charitable giving in Japan is not as prominent as in the United States.
The Power of Japan's Hometown Tax System
The hometown tax system in Japan has become a successful means of tax deductibility. It provides a way for high-earning individuals to contribute to specific causes and provides rewards for donors with nice things. The system also drives the entrepreneurial spirit by creating competition between different regions. However, the system can lead to uneven redistribution of funds and local governments can abuse it. The local governments have started to offer extra gifts as a means to boost their local revenue base by attracting more money from big cities. Therefore, the government has tweaked the regulations about the types and value of gifts that can be marketed. The hometown tax system is seen as a solution for rural areas in Japan.
The Pros and Cons of the Japanese Hometown Tax System
The Japanese hometown tax system is effective in incentivizing local production, but it also suffers from motivational crowding-out, where intrinsic motivation for paying taxes is replaced by extrinsic rewards that may erode compliance in the long term. The system's success also highlights the importance of incentives in economics, although over-reliance on them can break a pre-existing system of trust and reciprocity. The US could potentially adopt a similar system but would need to carefully consider the implications of competing agencies soliciting donations and eroding trust in government services. Incentives can be powerful tools, but their impact must be balanced against preserving a sustainable and equitable system.
How increased awareness of government processes can improve civic engagement
Increased awareness and engagement with government processes, such as tax allocation, can have a positive effect on citizens' relationships with the government and overall civic engagement. Although it may lead to frustration and a backlash effect initially, the conversation and accountability introduced by agency can lead to greater involvement and understanding. It is important to continue the dialogue and encourage government transparency for the benefit of all. This episode of Freakonomics Radio, produced by Stitcher and Dubner Productions, explores the potential benefits and challenges of government involvement. Contact radio@freakonomics.com with your own story ideas.