This week, David Elkins (Netanya) reviews a new article by Gary Lucas, Jr. (Texas A&M; Google Scholar), The Pain of Paying Taxes, 56 Richmond L. Rev. __ (2021) (forthcoming):
The financing of government spending (and in particular the financing of transfer payments) by taxation has been analogized in the literature to the carrying of water in a leaky bucket. In many cases, the amount received by the beneficiaries of the spending program will be less than the cost imposed upon the taxpayers. Under standard economic modeling, the sources of the leak include compliance costs, administrative costs, and the substitution effect (which occurs when taxpayers alter their behavior in order to avoid the tax or to minimize their tax liability). In a fascinating article, Professor Lucas argues that the leak may be larger than we thought. Leaving aside Oliver Wendell Holmes’ famous declaration that he does not mind paying taxes because taxes are the cost of a civilized society, people do not like to pay taxes. The psychological pain associated with paying taxes reduces social welfare and can also exaggerate the substitution effect.
Professor Lucas begins by reviewing the current literature on pain of paying in commercial transactions. One point I found particularly poignant was the argument that prepaid consumption involves less pain of paying than does postpaid consumption and that the effect is greater the longer the time gap between the two. In the case of prepaid consumption, the pain of paying is mitigated by the thought of future consumption. The consumer may even view the payment as an investment rather than consumption. Furthermore, when the time to consume finally arrives, the payment is already a past and perhaps somewhat forgotten event, meaning the consumption itself may be more enjoyable (“invest now, consume later, pay never”). Postpaid consumption operates in the opposite direction: the enjoyment of the consumption is mitigated by the knowledge of the future payment, and the pain of paying is intensified because the consumption that it financed is already a thing of the past. This analysis contrasts with standard present value economic theory, which states that consumers are better off the earlier the consumption and the later the payment. The article goes on to discuss the effect of bundling, salience, guilt, bargain-hunting, and method of payment on the pain of paying. One point that I thought needed a little more clarification was the claim that, because of discounting, the pain of paying will be less if deferred and particularly if it is deferred for a considerable period of time. This seemed to me to contradict the earlier demonstration that deferred payment generally increases the pain of paying.
The rest of the article is devoted to applying our knowledge regarding pain of paying to the structuring of taxation. For instance, the complexity of income tax reporting and the unclear link between payment and benefits imposes significant psychological pain on taxpayers. The author argues that simplifying the reporting procedure and instituting a marketing campaign highlighting the connection between tax and the government services that they finance could help mitigate the pain of paying taxes (I must admit that while I have little doubt with regard to the former, I am a bit more skeptical about the latter). Withholding, it is claimed, can also reduce the pain of paying.
With regard to the means of financing government services, the economic literature overwhelmingly prefers user fees, where practical, to general taxation such as the income tax. To the traditional efficiency and distributive arguments in favor of user fees, the author adds that the tight coupling of payment and benefit considerably reduces the pain of paying. To my mind that is indeed another strong argument in favor of user fees over general taxation. However, he adds, the coupling works both ways and the pleasure from using the service may be diminished by the associated payment.
One comment that I have is that at certain points the pain-of-paying argument seems to conflate into traditional economic analysis. For instance, when discussing social security payments, the author notes that the substitution effect is likely less than it would be under a payroll tax with no corresponding benefit, because the pain of paying is mitigated by the value attached to the benefit. However, one does not need to recognize pain of paying in order to achieve that result. Under traditional economic analysis, the “tax” is the excess of the amount paid over the actuarial value of the insurance coverage received (and is actually negative where the coverage is worth more than the payment). If the argument is that the reduction in pain of paying makes a separate contribution, I think it would be useful for that point to be articulated and substantiated.
The idea that the psychological pain of paying taxes is a cost that needs to be taken into account is an important contribution to the literature and merits entering the lexicon of the tax discourse.