Paul L. Caron

Wednesday, May 6, 2020

Thomas: Taxing Nudges

Kathleen DeLaney Thomas (North Carolina), Taxing Nudges, 106 Va. L. Rev. ___ (2020):

Governments are increasingly turning to behavioral economics to inform policy design in areas like health care, the environment, and financial decision-making. Research shows that small behavioral interventions, referred to as “nudges,” often produce significant responses at a low cost. The theory behind nudges is that, rather than mandating certain behaviors or providing costly economic subsidies, modest initiatives may “nudge” individuals to choose desirable outcomes by appealing to their behavioral preferences. For example, automatically enrolling workers into savings plans as a default rather than requiring them to actively sign up has dramatically increased enrollment in such plans. Similarly, allowing individuals to earn “wellness points” from attendance at a gym, redeemable at various retail establishments, may improve exercise habits.

A successful nudge should make a desired choice as simple and painless as possible. Yet one source of friction may counteract an otherwise well-designed nudge: taxation. Under current tax laws, certain incentives designed to nudge behavior are treated as taxable income. At best, people are ignorant of taxes on nudges, an outcome that is not good for the tax system. At worst, taxes on nudges may actively deter people from participating in programs with worthy policy goals. To date, policymakers have generally failed to account for this potential obstacle in designing nudges.

This Article sheds light on the tax treatment of nudges and the policy implications of taxing them.

It describes the emergence of a disjointed tax regime that exempts private-party nudges but taxes identical incentives that come from the government. What’s more, an incentive structured as a government grant may be taxable while an economically identical tax credit is not. The Article then proposes reforms that would unify the tax treatment of nudges and enhance their effectiveness. Specifically, lawmakers should reverse the default rule that all government transfers are taxable, and instead exclude government transfers from income unless otherwise provided by the Tax Code.

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Yes, taxation of nudges can create some problems, but only if they are positive nudges; giving a person something more or extra if he does a certain thing.

But negative nudges can be just as effective, and avoid just such tax consequences.

One major category of negative nudges - Differential Health Insurance Premiums - were one of the first to be studied.

Indeed, many years ago they were recommended for major health issues such as smoking and obesity by the National Association of Insurance Commissioners.

A common example is the provision which I helped to add to Obamacare under which smokers must pay an added surcharge to obtain their health insurance. It works, and it has no adverse tax consequences.

Another example would be if a business - including, for example, a law school or university - required soft drink vending machines to charge 5 cents more for a sugary soft drink than a similar diet soft drink.

This small nudge is going to force anyone to stop drinking sugary soft drinks - the major source of unnecessary sugar and calories in many diets - and it may help persuade people to think about switching.

For example, every once in a while a student may need a cold drink, and only have $1.00 to buy a Diet Coke from the vending machine, and not an extra nickle to buy the sugary Coke itself.

Posted by: LawProf John Banzhaf | May 6, 2020 6:31:29 AM