What if taxpayers don’t know everything?

(Crossposted at Core Economics)

One of the most interesting fields in public economics these days is behavioural public finance, which starts from the idea that maybe (just maybe) our standard assumption that every taxpayer has perfect information about the tax system is a little overstated. If true, it suggests that perhaps we can induce behavioural changes not by changing policy parameters, but by changing the information available to people. Here’s a clever example:

Teaching the Tax Code: Earnings Responses to an Experiment with EITC Recipients
Raj Chetty and Emmanuel Saez
This paper tests whether providing information about the Earned Income Tax Credit (EITC) affects EITC recipients’ labor supply and earnings decisions. We conducted a randomized experiment with 43,000 EITC recipients at H&R Block in which tax preparers gave simple, personalized information about the EITC schedule to half of their clients. Tracking subsequent earnings, we find substantial heterogeneity in treatment effects across the 1,461 tax professionals who assisted the clients involved in the experiment. Half of the tax professionals, whom we term "compliers", induce treated clients to increase their EITC refunds by choosing an earnings level closer to the peak of the EITC schedule. Clients treated by complying tax professionals are 10% less likely to have very low incomes than control group clients. The remaining tax preparers generate insignificant changes in EITC amounts but increase the probability that their clients have incomes high enough to reach the phase-out region. Treatment effects are larger for the self-employed, but are also substantial among wage earners, suggesting that information provision induced real labor supply responses. When compared with other policy instruments, information has large effects: complying tax preparers generate the same labor supply response along the intensive margin as a 33% expansion of the EITC program, while non-complying tax preparers induce the same response as a 5% tax rate cut.

Behavioural public finance has surely got to be important when it comes to the byzantine Australian tax-transfer system. However, I’m not sure how well it sits with the idea that tax experts need to spend more time listening to the wisdom of practical people.

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One Response to What if taxpayers don’t know everything?

  1. Kevin Cox says:

    Andrew,

    I would go much further than just giving people information.

    The tax system should be constructed so that it works out for me the best way to structure my financial affairs for tax purposes. A system which depends on my ability to read 1000+ pages and understand is ridiculous when most of the rules are to do with stopping people trying to abuse the system. If I tell the tax office all the information they need from me to calculate my fair proportion of tax and I am willing to take its advice then the system should be able to work it out and tell me. If it can’t then we should change the system.

    Also the tax system should stop being used for other purposes – the sending out of cheques in the stimulus package is the latest abuse of the tax system by the government and by lazy bureaucrats who cannot bother to take the time to think of other ways of distributing money.

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