Stealth Taxes

Frances Woolley argues the case for hidden taxes:

Visible taxes can lead to bad policy choices when a tax's visible incidence is different from its actual incidence. The average tax payer will vote for a tax/benefit scheme that appears to be in his or her interests - for example, increased health care spending financed by increased corporate income taxes - not realizing that the burden of the corporate income taxes might be shifted forward onto customers or backwards onto employees - in other words, right back onto the average tax payer.

It's a nice second-best argument. And, consistent with one of my favourite papers in experimental economics (previously discussed here): Sausgruber and Tyran's finding that buyers in a double-auction will happily vote for inefficient redistribution programmes framed as a tax on sellers but will oppose it when framed as a tax on buyers, despite equivalent incidence.

I'm not sure that a tax's invisibility necessarily protects against stupidity. New Zealand's clean GST is built into consumer prices; there's still not unreasonable pressure to wreck it by exempting food. But, that Labour's only advocated the wrecking ball when safely away from the Treasury benches suggests something.

Frances continues:

A final argument for stealth taxation is that it facilitates budget balance.  People want good things from their governments, like health care and old age pensions. But they don't want to pay taxes. So the temptation is to vote for spending initiatives and vote against any tax increases. When taxes become more visible, people become more aware of the taxes that they are paying, and lobby harder for tax cuts. The result: future generations are burdened with debt and taxes.

Now the argument could be made that in fact invisible taxes contribute to government debt - if the average voter realized how little he benefited from the Bush (Bush-Obama?) tax cuts, how much those tax cuts benefitted the richest Americans, and just how mind-bogglingly rich the richest Americans are, perhaps he would have voted against them. I don't know of any decisive evidence on this point, so if you disagree, feel free to say so in the comments.

Some degree of visibility in taxation is desirable - without information how the tax system works, and who bears the burden of taxation, it is difficult to make good policy decisions.

This is a fun one to think through. Specify that voters are largely ignorant but will vote against anybody they think is to blame for bad outcomes. And, specify a Westminsterian system so they know who's to blame for bad outcomes. In that world, I'm not sure whether it matters a lot whether the taxes are hidden or visible. If taxes with too high of deadweight losses are used to fund services of too little value, incumbents get turfed. Maybe it takes slightly longer if policy has lagged effects. Retrospective economic voting then saves things. If there's no opacity, the ruling party has to balance losses from bad effects of policy against loss in popularity from running "works, but unpopular" policy. At least there's weight on the effects of policy despite voters not knowing a damned thing except what they see out the window.

In a political system where responsibility attribution is more difficult - either Parliamentary with PR and powerful committees or a Presidential system with strong division of power and a federalist structure - things are harder to work out and could then persist longer. Then there's rather less incentive to weigh the effects of policy; rather, you blame the President if you're Congress, blame the other party in Congress if you're the President, blame the State if you're local government. Blame gets spread and incentives for good policy are flattened.

I'm also not sure that complete opacity is as good an idea in a Brennan-Buchanan Leviathan taxation world than in a Musgrove benevolent despot one.

Tax incidence

Matt Nolan rightly notes that tax incidence in general equilibrium after prices have adjusted is far more complicated than just "this guy gets $25 more per week after a tax cut while this guy only gets $0.50" linear estimates from the initial change in tax rates.

That's true, of course, but the problem is bigger.

Matt starts by assuming that folks kinda get the scissors of supply and demand and that relative price elasticity determines tax incidence: statutory incidence is irrelevant. For simplicity, imagine a tax charged on the seller of a good that is perfectly elastic in supply and perfectly inelastic in demand. It currently sells for $5. The government says they'll charge the seller a $1 per unit tax. Voters love it because the sellers are big business, and everybody hates big business. Had it been a tax levied at point of sale on consumers, they'd have wailed and gnashed teeth because that's a tax on the poor customers who buy the goods. Of course, in this example, the price paid by consumers jumps to $6 regardless of whether the statutory incidence falls on consumers or producers. It's relative elasticity that decides who bears the incidence of the tax, not statutory incidence. And the inelastic side of the market bears the burden.

But voters are utterly incompetent at understanding this.

And here's the nicest bit of evidence on it from one of my very favorite experimental economics pieces of all time. Rupert Sausgruber and Jean-Robert Tyran's "Testing the Mill Hypothesis of Fiscal Illusion". I'd pointed to it in this prior post, but buried amongst other things.

Here's the experiment. Put a bunch of folks in a computer lab. Tell them they're buyers of good X. Each of them values good X at different amounts: the experimenter tells each buyer that he'll buy X from them at different prices for different quantities. That generates individual and aggregate demand schedules. Put in a computerized seller with a set supply curve. Let folks run a few rounds of trading with the computerized seller.

Then, let the buyers take a vote on an inefficient redistribution mechanism. If the resolution passes, a tax will be imposed on the buyers, per unit sold. The collected money will be divided evenly among buyers, but with some of it taken off the top as waste. Surprise surprise, nobody much wants that mechanism. Then, reframe it as a tax on the seller. Let them vote again. And, the buyers love it. Never mind that the incidence of the tax is identical across the two treatments. Indeed, in their design, the incidence falls entirely on consumers.

And that's why politicians love to use statutory incidence to frame things for voters. ACC: that's paid for by employer contributions as well as employee. Employees, you don't have to worry about the part your bosses pay. Corporate taxes: who likes companies other than hard-hearted economists? Producer taxes. When Canada shifted from the Manufacturer's Sales Tax to the GST, lots of idiots complained because where companies previously paid the tax, NOW the tax was going to be paid by consumers; Canada wound up with a pretty dirty GST, but still better than the prior manufacturer's sales tax.

In the Tyran and Sausgrubber experiment, voters eventually figured out that they bore the incidence and eventually voted against the inefficient redistribution mechanism. But that's in an experimental setting where the only things changing in the world are whether the scheme is in place or not. Under those conditions, it's pretty easy for the traders to see that the policy makes them worse off. But the real world is noisy, and there are always a hundred other things that voters can blame for the effects of their preferred policy. Indeed, they may wind up arguing that the business was evil for putting prices up when the tax was implemented and that regulations are needed to ensure that the tax works as it was "meant to".

Always ALWAYS beware of taxes that purport to fall on disfavoured groups. The economic incidence may not be what you're hoping it'll be. And that's even before all of the GE complications come in.

I teach this in my third year public choice class at Canterbury. Third year students, almost all of them econ majors. And at least half of them don't understand tax incidence before I show it to them prior to showing the Sausgruber and Tyran result. If folks almost finished an econ major don't get it, there's absolutely no hope in expecting voters to get it. And, of course, politicians well know that only statutory incidence matters to most voters, and so we get the policies we get.