The Psychology of Taxes

No one enjoys paying taxes. For many, the most grueling exercise when budgeting is seeing the amount deducted from one's paycheck by the government. For this reason, tax avoidance has been a business that is almost as old as taxes themselves. From personal to professional, tax avoidance has become a common practice across many cultures and seems to be here to stay.

As a result, countries much consider the psychology of the taxes they impose. A hallmark of behavioral finance is that the average person is not always rational when it comes to economic options. Practically, what this means is that people are more willing to pay for things that align with what they want. This is an obvious observation, but it allows governing bodies to think about how to best administer taxes so that people may be more inclined to pay them - rather than dodge them.

A large study was performed and showed different ways of inducing people to pay their tax bill. In the United Kingdom, the Imperial College of London as well as the University of Chicago sent out letters that accompanied people’s tax bill. Some were generic saying that they owed a certain amount and the date the payment was due by, while others pulled on the heart strings of the taxpayer. Some pointed out how many other taxpayers paid on time and that they would be in a small minority if they did not. What this study showed was that the differences has a significant effect. One’s payment of their taxes was paid more quickly when the taxpayer received a letter that differed from the base line generic letter.

This poses interesting options for government’s moving forward. Psychological effects in taxes have always been considered by governments (such as taxing capital gains at a lower rate to inspire more investment) but mostly in administering the taxes, not in the collection stage of the process. Making an emotional case or informing the taxpayer of their standing compared to others in the country may help the likelihood and timing of payment, but should governments be manipulating its constituents like this? That is a question for behavioral finance.