Catching up on tax-related news, from Monday’s Washington Post comes this column by Shankar Vedantam. Consider:
Economists have long known there are two reasons that people cheat on their taxes. One is that they are poor and need the extra cash so badly they are willing to risk getting caught. The other is that they are rich and have lots of “non-matchable” income — mostly investment income not directly reported to the government — which makes it less likely they will be caught.
Taxpayers in the middle class are the least likely to cheat: They are not struggling to make ends meet, and their income is mostly wages, which are directly reported to the Internal Revenue Service. If you measured the likelihood of tax evasion by income level, in other words, the graph would look like a giant U.
For reasons I don’t feel like delving into (the use of under-reported income estimates among them), he’s wrong. See Kip’s prior analysis here and here for evidence. Instead I want to focus on this “solution”:
Other experts are considering more creative ways to improve tax compliance. One idea is to take advantage of people’s desire to get a refund at the end of the year.
“What some people do when they are doing their taxes is they do a first draft and see how much they are getting back,” said Richard Thaler, a University of Chicago economist who studies how people think about money. “If they owe money, then they do a second draft. They keep finding deductions until the refund is positive.”
Thaler said mandatorily increasing withholding levels so more people get refunds could increase compliance because taxpayers would no longer have to go to great lengths to get a refund.
There are (at least) two problems here. First, the government shouldn’t be in the business of promoting people to
engage in irrational behaviors offer interest-free loans. (And yes, by promoting, I mean forcing.) Of course it would help the government to implement this policy. But that assumes that the government is supreme over the people, granting reasonable income policies and so forth. That’s backwards.
Second, if people are willing to “keep finding deductions”, what’s to stop them from being greedy and seeking deductions to increase the positive refund? Does human nature recognize a limit to greed¹ and stop once it gets a little if it can get a lot? If most middle-class taxpayers get a refund, it seems there’s a built-in incentive to cheat. Most probably won’t do it, but that doesn’t mean it’s not there. Fix the incentives by fixing the tax code and the incentive to cheat diminishes.
¹ I’d argue it’s stupidity rather than greed if you’re scheming to figure out ways to get your own money back up to sixteen months later than necessary. But the point holds.