Fear and Greed in Tax Policy: A Qualitative Research Agenda

ed =312141; ARMIN FALK ET AL., INFORMAL SANCTIONS 31-32 (U. of Zurich, Inst. for Empirical Research in Econ., Working Paper No. 59, 2000), http://papers.ssrn.com/sol3/ delivery.cfm/SSRN_ID245568_code001011130.pdf?abstractid=245568 (testing for reciprocal behavior in Internet and classroom laboratory experiments and concluding that reciprocity decreases with increased social distance but is not eliminated). 8. See, e.g., Kahan, supra note 4, at 340-44 (noting relevance of public goods experiments for tax-enforcement policy). http://openscholarship.wustl.edu/law_journal_law_policy/vol13/iss1/4 p 75 Fennell.doc 9/22/03 2003] Fear and Greed in Tax Policy 79 I. MAPPING TAX AVERSION It borders on the insipid to observe that most people dislike paying taxes. Perhaps for this reason, virtually no systematic work has been undertaken to gauge whether taxes are more aversive than other sorts of costs or losses. To be sure, a great deal of study has focused on questions of tax compliance. Additional studies have examined how taxpaying might be made to feel fairer or less burdensome to taxpayers. Notably, scholars have observed that reactions to survey questions about taxation are mutable and depend on the framing of the question—a fact that problematizes the study of taxpayer attitudes, even as it provides clues to the nature and tractability of tax aversion. While this body of existing research concerning compliance burdens and perceptions of equity touches on and implicates instances of tax aversion, we think the phenomenon of aversion warrants a more direct exploration. A functional definition of the kind of tax aversion we wish to investigate is the amount by which one’s aversion to a tax exceeds the economic cost of the tax. A symptom of this kind of tax aversion would be a willingness to expend more on tax avoidance (or risk more through tax evasion) than is warranted by the economic cost 9. E.g., ALAN LEWIS, THE PSYCHOLOGY OF TAXATION 123-87 (1982); TAX EVASION: AN EXPERIMENTAL APPROACH (Paul Webley et al. eds., 1991) [hereinafter TAX EVASION]; WHY PEOPLE PAY TAXES: TAX COMPLIANCE AND ENFORCEMENT (Joel Slemrod ed., 1992); Carroll, supra note 4; John T. Scholz & Neil Pinney, Duty, Fear, and Tax Compliance: The Heuristic Basis of Citizenship Behavior, 39 AM. J. POL. SCI. 490 (1995). 10. E.g., Gregory A. Carnes & Andrew D. Cuccia, An Analysis of the Effect of Tax Complexity and Its Perceived Justification on Equity Judgments, 18 J. AM. TAX’N ASS’N 40 (1996); RONALD G. CUMMINGS ET AL., CROSS-CULTURAL COMPARISONS OF TAX COMPLIANCE BEHAVIOR (Ga. State Univ., Int’l Studies Program Series, Working Paper No. 01-3, 2001), available at http://isp-aysps.gsu.edu/papers/ispwp0103.pdf; Thomas M. Porcano & Charles E. Price, Some Evidence on the Association Between Judgment Criteria and Fairness Perceptions, 4 ADVANCES IN TAX’N 183 (1992); Martha L. Wartick, Legislative Justification and the Perceived Fairness of Tax Law Changes: A Referent Cognitions Theory Approach, 16 J. AM. TAX’N ASS’N 106 (1994). 11. E.g., LEWIS, supra note 9, at 47-49 & tbl.4.2 (discussing notorious malleability of survey responses and presenting table entitled “How to Record the Fiscal Preferences You Want from Attitude Surveys and Public Opinion Polls”). 12. TAX EVASION, supra note 9, at 2 (distinguishing tax avoidance, which involves legal efforts to reduce tax liability, from tax evasion, which involves illegal efforts to reduce taxes). For additional studies of issues in tax avoidance and evasion, see, for example, BRUNO S. FREY & LARS P. FELD, DETERRENCE AND MORALE IN TAXATION: AN EMPIRICAL ANALYSIS (Ctr. for Washington University Open Scholarship p 75 Fennell.doc 9/22/03 80 Journal of Law & Policy [Vol. 13:75 of the tax. A substantial body of experimental literature indicates that people are willing to incur positive costs to keep others from getting away with conduct they perceive as unfair, and we believe that a similar dynamic might operate to heighten avoidance and evasion in the tax context. An example will illustrate the point. Imagine that Borg can reduce his tax bill either legally (by consuming tax deductible items) or illegally (by fabricating deductions). He can also simply pay the tax. In making the decision about avoidance, he should compare the tax-discounted price of the deductible item in question with the utility it generates for him. For example, if he is in a 36% marginal tax bracket and contemplates attending a conference that costs $1000 in real dollars (and if we further assume that his tax situation allows the full deduction of this amount), he should rationally attend the conference only if attending is worth more than $640 to him. If he subjectively values attending the conference at just $600, but attends because he wants to take the tax deduction, this suggests either irrationality, innumeracy, or an additional factor that makes taxes more painful than the dollar figure suggests (or, alternatively, that makes a tax savings of $360 more attractive to him than that dollar figure indicates). We call that additional factor “tax aversion.” Do people actually take tax deductions beyond the economically justified point or otherwise engage in nonoptimizing behavior with regard to tax avoidance? Some have intuited that this indeed occurs, and anecdotal evidence supports the proposition. For example, Econ. Studies & Ifo Inst. for Econ. Research, Working Paper No. 706, 2002), http://papers.ssrn.ocm/sol3/delivery.cfm/SSRN_ID341380_code021021590.pdf?abstractid=341 380; J. Slemrod & S. Yitzhaki, Tax Avoidance, Evasion and Administration, in 3 HANDBOOK OF PUBLIC ECONOMICS 1423-70 (A.J. Auerbach & M. Feldstein eds., 2002); J. Andreoni et al., Tax Compliance, 36 J. ECON. LITERATURE 818 (1998). 13. See infra notes 37-47 and accompanying text (discussing studies involving dictator, ultimatum, and power-to-take games). 14. See supra notes 9, 12 (citing studies of compliance, evasion and avoidance). 15. We use the thirty-six percent marginal tax rate here for illustrative purposes only; actual marginal tax rates have been changing as a result of recent legislation. See I.R.C. § 1(i). Other provisions of the Internal Revenue Code address the availability of deductions. See, e.g., I.R.C. § 67(a) (establishing a floor for certain itemized deductions); I.R.C. § 68 (setting limits on allowable itemized deductions for taxpayers above a certain income). For purposes of this simple illustration, we ignore the complications associated with those limits. 16. E.g., McCaffery, supra note 1, at 1914-15 (suggesting people may consume http://openscholarship.wustl.edu/law_journal_law_policy/vol13/iss1/4 p 75 Fennell.doc 9/22/03 2003] Fear and Greed in Tax Policy 81 Texas has an annual “sales tax holiday”—a few days each August during which shoppers may purchase selected items free of sales tax. News articles covering the event note the huge crowds that descend upon stores to take advantage of this opportunity and the fact that some individuals make rather extraordinary expenditures in connection with it. The savings are not large, with a sales tax of 8.25% in cities such as Austin, and some commentators quite reasonably speculate that merchants do not offer prices as low as they might in the absence of the tax break. However, monetary savings may not be the only factor motivating the behavior. As one shopper articulated, “there’s something to be said for finally beating the government at something.” However, we know of no empirical study of such manifestations of tax aversion. Designing such a study would not be easy. For example, consider the difficulties that would be involved in attempting to measure whether an effective price change resulting from a change in tax treatment had a larger or smaller impact on consumer demand than a similar price change resulting from market deductible items beyond the point of optimality); id. at 1915 (making a similar point regarding the use of unprofitable tax shelters). 17. Rod Kurtz, A Buyers’ Bonanza, AUSTIN AMERICAN-STATESMAN at A1, A10 (Aug. 3, 2002) (describing expenditures such as staying in hotels in order to be closer to the stores when they open). 18. Id. at A10 (quoting Pamela Krisan, a shopper taking advantage of the Texas “tax holiday”). Of course, one might argue that attitudes towards taxation in Texas, a state that has long resisted enacting an income tax, do not necessarily typify those that prevail nationwide. However, organized events such as sales tax holidays and time-limited amnesty offers for taxpayers incorporate the characteristics of “inversion” or “reversal” rituals that anthropologists have found to be a frequent component of secular rituals within stratified societies. Such inversion rituals serve to relax normal societal and legal rules within a bounded context and time period. By relaxing, or reversing, the existing legal rules within such limited frameworks, sales tax holidays and amnesties can serve to reinforce and emphasize the applicability and enforceability of those rules at all other times. VICTOR TURNER, THE RITUAL PROCESS 172-78 (1995); Evon Z. Vogt, Rituals of Reversal as a Means of Rewiring Social Structure, in THE REALM OF THE EXTRA-HUMAN: IDEAS AND ACTION 201-11 (Agehananda Bharati ed., 1976); see also Joshua D. Rosenberg, The Psychology of Taxes: Why They Drive Us Crazy and How We Can Make Them Sane, 16 VA. TAX REV. 155, 219 (1996) (finding tax amnesty effective when “taxpayers perceive that the amnesty will be followed immediately by substantially increased enforcement of the law”). 19. In a 1994 article, Edward McCaffery noted this lack of empirical work on the question of excessive avoidance behaviors: “I am aware of no study that pins this particular phenomenon down. Thus, this discussion remains anecdotal for now.” McCaffery, supra note 1, at 1915. Washington University Open Scholarship p 75 Fennell.doc 9/22/03 82 Journal of Law & Policy [Vol. 13:75 forces. The unavailability of existing data suitable for these purposes and the difficulty in formulating a method for successfully collecting such data outside of a controlled laboratory experiment present daunting challenges. Nevertheless, beginning to imagine what such a study might look like can help set the stage for innovative research in this area. Another possible manifestation of tax aversion might be increased evasion. Recall that Borg has the ability to fabricate deductions rather than actually consume deductible items. In deciding whether or not to fabricate deductions, many factors could play a role, but on a strict economic analysis we imagine that Borg will compare the expected cost of fabricating the deduction (a product of the probability of detection multiplied by the costs of defending himself and paying penalties for this sort of tax evasion) with the expected tax benefit to be derived from the fabrication. If Borg fabricates a deduction for $1,000, it yields him $360 in tax benefits. To be “worth it” for Borg to break the law, the expected value of punishment for violating the law must be less than $360. If Borg runs a one percent chance of being caught and expects to suffer defense and punishment costs of $40,000 if caught, the expected value of such costs equals $400. 20. For an overview of some of the methodological considerations and complications associated with the design of empirical studies, see E. Allan Lind, John E. Shapard, & Joe Shelby Cecil, Appendix B: Methods for Empirical Evaluation of Innovations in the Justice System, in EXPERIMENTATION IN THE LAW: REPORT OF THE FEDERAL JUDICIAL CENTER ADVISORY COMMITTEE ON EXPERIMENTATION IN THE LAW 81, 88-112 (1981). 21. See ROSEN, supra note 2, at 326-27 (presenting a more detailed account of an individual’s tax evasion calculation). 22. This hypothetical probability of detection exceeds actual audit rates in recent years. For taxpayers with less than $100,000 in annual income, the probability of being subjected to a federal income tax audit was 1.60% in fiscal year 1995, 1.58% in 1996, 1.19% in 1997, 0.92% in 1998, 0.86% in 1999, 0.45% in 2000, and 0.55% in 2001. INTERNAL REVENUE SERVICE, PROGRESS REPORT FROM THE COMMISSIONER OF INTERNAL REVENUE 43 (Dec. 2001), available at http://www.irs.gov/pub/irs-utl/pub3970_2-2002.pdf. The audit rates in these years for taxpayers with annual incomes of $100,000 or more were 2.97% in 1995, 3.21% in 1996, 2.74% in 1997, 2.01% in 1998, 1.40% in 1999, 0.96% in 2000, and 0.79% in 2001. Id. Moreover, the penalty amount we have posited far exceeds the monetary penalties actually imposed. The actual penalty levels under current law call for payment of the tax due, accrued interest on that amount, plus a penalty of twenty percent of that tax amount if underpayment resulted from negligence or substantial understatement of taxes due. I.R.C. § 6662. The penalty level increases to seventy-five percent of the tax amount due if the taxpayer underpaid as a result of fraudulent conduct. Id. § 6663(a). Our hypothetical assumes that Borg would incur substantial additional costs in defending himself against an audit and subsequent legal http://openscholarship.wustl.edu/law_journal_law_policy/vol13/iss1/4 p 75 Fennell.doc 9/22/03 2003] Fear and Greed in Tax Policy 83 Because this cost exceeds the monetary savings associated with the fabricated deduction, we do not expect a rational Borg to fabricate. However, if we posit that another factor makes the fabricated deduction worth more than what the dollar value suggests, the calculation might change. How might we measure whether people are actually adding in an additional “kicker” associated with tax aversion in making evasion decisions? It might seem that they are doing exactly the opposite. Relatively few people evade taxes, even though we might expect the combination of low audit rates and low penalties to make evasion attractive from the standpoint of rational calculation. Yet people likely overestimate the probability and severity of punishment, and also give unknown amounts of weight to intangible factors such as guilt and shame in their decisionmaking. Because tax evasion is notoriously difficult to detect and to distinguish from unintentional taxpayer errors, it is hard to gain much insight into subjective taxpayer calculations based on detected instances of evasion. A number of controlled laboratory experiments have attempted to measure and evaluate tax evasion. However, evasion in these contrived settings arguably does not compare with real-world evasion. It is impossible to accurately estimate the perceived proceedings, and would also suffer significant intangible disutility associated with detection and punishment. 23. Overall compliance rates in recent years have exceeded eighty-three percent. CUMMINGS ET AL., supra note 10, at 3 n.3. 24. Id. at 3-4; see ROSEN, supra note 2, at 328 (noting the “psychic costs of cheating”). 25. LEWIS, supra note 9, at 124-26; Paul Webley et al., The Problem of Measurement, in TAX EVASION, supra note 9, at 29, 30-35; Carroll, supra note 4, at 509. 26. See supra notes 9, 12 (citing studies on evasion and compliance enforcement efforts). 27. For example, participants may view the experimental interface as a game and may not view decisions about evasion with the same moral seriousness (or with the same fear of humiliation and punishment) as they might in the real world. Paul Webley et al., The Subjects’ View, in TAX EVASION, supra note 9, at 114; Paul Webley & S. Halstead, Tax Evasion on the Micro: Significant Simulations or Expedient Experiments?, 1 J. INTERDISC. ECON. 87 (1986); see also Susan Long & Judyth Swingen, The Conduct of Tax-Evasion Experiments: Validation, Analytical Methods, and Experimental Realism, in TAX EVASION, supra note 9, at 128, 136-37 (observing that tax evasion experiments do not involve the threat of non-financial punishments such as imprisonment). On the other hand, some participants may shun evasion behaviors in the experimental setting out of a desire to appear “honest” to the experimenter or otherwise provide responses they believe the researchers desire. See, e.g., Webley et al., The Subjects’ View, supra, at 114, 117. Washington University Open Scholarship p 75 Fennell.doc 9/22/03 84 Journal of Law & Policy [Vol. 13:75 severity of punishment that confronts taxpayers (which includes individual subjective valuations of being imprisoned or fined, as well as any dollar amounts paid in penalties or defense costs) or taxpayers’ perceptions of the probability that a given fabrication will be detected. A qualitative study that attempts to tap into the calculations made by tax evaders would provide invaluable help in this regard. Heightened avoidance and evasion do not adequately capture all of the costs associated with tax aversion. Some taxpayers have little ability to avoid or evade taxes or may reach limits in their ability to take advantage of these tactics. For others, even inflated measures of benefits derived from avoiding or evading taxes provide insufficient triggers for avoidance or evasion because the costs still loom higher. Hence, Borg might neither evade nor avoid, but instead simply suffer the disutility associated with tax aversion. We might also wish, then, to measure the increased disutility that accompanies tax aversion, even when not manifested in changed avoidance or evasion behavior. The theoretical question is easy enough to state: whether taxes are more painful than other economically equivalent events. An economically equivalent event would be a gain or a loss through some means other than taxation that has an equal dollar value to the gain or loss associated with the tax payment and the corresponding benefits received. However, a difficulty arises when we attempt to pin down whether a given taxpayer has enjoyed a gain or suffered a loss as a result of a tax payment. If we show a rational individual a world in which no tax-financed goods exist (including no government, no courts, no police, no national defense, no schools, no roads, and so on) and ask her how much she would pay to move from 28. Taxpayers may also make different calculations regarding evasion depending on whether they view themselves as facing a loss (taxes due at year’s end) or a gain (refund already forthcoming). For a recent review of the literature on this point, see Chris Guthrie, Prospect Theory, Risk Preference, and the Law, 97 Nw. U.L. REV. 1115, 1142-45 (2003). 29. It is also possible that tax aversion not immediately manifested behaviorally due to lack of opportunity might translate into behavioral manifestations at a later time when opportunities become available to the individual taxpayer. Another theoretical possibility, unexplored to our knowledge, is whether frustrated tax aversion might be redirected into noncompliant behavior in other interactions with the government, such as benefit claims. http://openscholarship.wustl.edu/law_journal_law_policy/vol13/iss1/4 p 75 Fennell.doc 9/22/03 2003] Fear and Greed in Tax Policy 85 this chaotic world to one in which our current slate of tax-financed goods exists, the answer would surely exceed the amount that the individual pays in taxes. However, it does not follow that individual taxpayers would not choose, at the margin, to pay lower taxes and receive fewer services, provided they could pick and choose which services to continue receiving and which ones to jettison. A potentially more useful approach brackets the theoretical question by identifying the economic events that occupy the extreme ends of a spectrum of financial transactions: market exchanges and uncompensated losses. On the one hand, we expect that a tax would generate more aversion than would a market transaction. Unlike a market transaction, a taxpayer does not choose her owed payment (except in the limited sense suggested by opportunities for evasion or avoidance), and a tax payment does not yield an immediate, tangible object of exchange. On the other hand, a tax is not quite the same as a theft or other uncompensated loss; it does go somewhere and yields at least some benefits (ambient or otherwise) for the taxpayer. It seems that a tax occupies a middle ground between loss and exchange—an intermediate status further complicated both by the possibility of free riding and the lack of any rhetorical connection (at least with respect to the federal income tax) between payments made and benefits received. Do people perceive taxes more like losses, exchanges, or some third mental category of expenses, such as bad gambles or mandated purchases? Or do they attempt to mentally disaggregate the portion of their taxes that corresponds to identifiable benefits from the extra amount they must pay to “carry” or cross-subsidize full or partial free 30. See LIAM MURPHY & THOMAS NAGEL, THE MYTH OF OWNERSHIP 16 (2002) (arguing that “the baseline for determining the benefits of government is the welfare a person would enjoy if government were entirely absent; the benefit of government services must be understood as the difference between someone’s level of welfare in a no-government world and their welfare with government in place”); cf. RICHARD A. EPSTEIN, TAKINGS 210 (1985) (observing that “a court could place all legislative initiatives past and future in a single hopper and proclaim that the benefits and burdens are always proportionate, thereby gutting the takings clause for general regulation”). 31. Cf. Lee Anne Fennell, Beyond Exit and Voice: User Participation in the Production of Local Public Goods, 80 TEX. L. REV. 1, 9 (2001) (differentiating between the consumption good of public education or safety and the composite good that results from the communitywide pattern of consumption of these goods). Washington University Open Scholarship p 75 Fennell.doc 9/22/03 86 Journal of Law & Policy [Vol. 13:75 riders, so that they perceive the tax as a bundle containing some exchange value and some loss? If so, does the fact that free riding occurs make the loss greater than the number of dollars involved indicates? Does the fact that one is interacting with the government change the situation? Does the compulsory nature of the collection add to the disutility? Surprisingly, few studies address this set of questions in the tax context. One possible line of qualitative research into these questions could use survey questions and interviews to probe the relative degree of disutility associated with a variety of ambiguous expenditures of a particular sum of money, all of which straddle the middle ground between loss and exchange. Such data could help identify the features that contribute to tax aversion and provide a richer understanding of how people perceive taxes. While a full experimental design protocol is beyond the scope of this paper, we suggest starting with something like the survey questions listed in Figure 1. 32. As discussed below, identifying when and whether one is actually subsidizing or carrying free riders (as opposed to simply purchasing a redistributive public good with ambient benefits or purchasing social insurance against potential risks) proves to be a difficult and controversial task. http://openscholarship.wustl.edu/law_journal_law_policy/vol13/iss1/4 p 75 Fennell.doc 9/22/03 2003] Fear and Greed in Tax Policy 87