Tax and human nature: the good, the bad and the ugly
James Paull, Head of the Incentives group at Andersen in the UK, discusses how different tax systems provoke different behaviours, and to what extent this is impacted by unconscious biases.
James’ article was published in Accountancy Daily, 9 March 2021, and can be found here.
Most taxpayers who have just paid their January bill may now be wondering how their future HMRC returns will evolve in response to the widely anticipated tax increases, once they are announced.
Among the potential issues that arise is just how much different tax systems provoke changes in behaviour and vice versa, and to what extent this is impacted by unconscious biases. When reviewing the landscape since the Covid-19 pandemic first took hold, the distorting effects of cognitive biases are readily apparent. An obvious corollary is the potential for tax rises and associated behavioural changes.
In examining the complex interaction between tax and behaviour, the effects can be sub-divided into three broad categories: the good, the bad and the ugly.
To fund public services, most taxpayers accept the need for a comprehensive tax system. But for this to have majority support, there must also be a general consensus that the system is fair.
First published in 1776, Adam Smith’s Wealth of Nations outlined four canons of good taxation: equality (equity), certainty, convenience and efficiency. For equality to be achieved, the amount of tax should be proportionate to the abilities of the taxpayer. Certainty means that taxpayers are clearly informed about why and how taxes are levied, while convenience and efficiency concern ease of compliance, costs of collection and minimising economic distortion.
Every system will distort behaviour to some degree. But when the boundaries of perceived fairness are pushed too far, these distortions invariably become more acute. A prominent example was the introduction of a new 50% income tax band in 2010, which fuelled the appetite for tax planning. In the event, this new band did not raise material revenue, partly because of the distortions outlined above. Within three years, the rate had dropped to 45%. The Treasury and the Chancellor should perhaps bear this in mind before deciding whether or not to align CGT rates closer or equal to income tax.
At a micro level, there are several instances where “good” behaviours have been effectively encouraged by taxation. Examples include the tax on single-use plastic bags tax and vehicle excise duty based on CO2 emissions levels. However, establishing a link between increased alcohol and tobacco taxes and good behaviour is harder to determine, perhaps because insufficient transparency exists on how much tax is paid on individual items.
Although a case can always be made for tax rises to bolster public spending increases in hard times, Smith’s canons should never be forgotten.
Get them wrong and excessive distortions of behaviour may follow. Behavioural risks must therefore be analysed to identify how material these might be. Are there simple steps to avoid? The answer lies in in balancing these risks against potential revenues that may be raised from specific tax increases; they do not necessarily lead to an increase in net tax take.
Regrettably, some behaviours elicited by the tax system demonstrate a less attractive side of human nature.
Although raising taxes on purely ideological grounds is unlikely to meet the fairness test, it is very likely to be counterproductive. While the ideologue will not care, ordinary taxpayers should care a great deal. The usual result is to place an increased burden on the wealthy and high earners, which runs the risk of driving this relatively small group away to other jurisdictions. That burden then falls on those who remain. Furthermore, it provides a disincentive for inward investment and high earning immigrants who might want to come to the UK.
Another unattractive behavioural trait is manifested by those who support tax rises, but only if someone else has to pay them. A recent You Gov survey concerning a possible wealth tax found that 61% were in favour of it, but only if property and pensions (the principal sources of wealth for most British people) were excluded.
The mainstream media can play an important role in policing unacceptable behaviours surrounding tax. Too often, however, the opportunity is lost as an apparently wilful conflation of tax evasion and avoidance, revenues and profits punctuates the narrative of their reporting. Although professional journalists can reasonably question how taxable profits have been arrived at, they should also consider the multiple reliefs which could significantly and legitimately reduce those profits.
The highly complex interaction between the tax system and human nature can bring out some of the best and worst behaviours. There are no easy solutions to prevent them. Diverse competing agendas – political and economic – make it impossible to please all of the people all of the time. But when the central message of an economic theory has survived for almost 250 years, that is probably because it contains real substance. Perhaps every stakeholder should pause to think about this when deciding their behavioural responses in relation to tax, and ignore the background noise.