We can be sure that tax and tax “reform” will be a big topic (yet again) this year, but what will get less attention is how behavioural economics explains the shape of the existing tax system and makes it hard to change.
I read that this year we may attain the economists’ Holy Grail of replacing state conveyancing duty with a broad-based annual tax on the unimproved value of land under people’s principal residence.
Economists regard taxing homes whenever they change hands as highly economically inefficient because it discourages people from moving when they need to move, whereas taxing the ownership of land as highly efficient because it’s hard to avoid and is naturally “progressive”, hitting the rich harder than the poor.
Holy grails are, however, wondrous things, but almost impossible to attain. Economists have been preaching the virtues of such a switch for at least the past 30 years, with precious few converts (bar, in recent times, the ACT government).
Why have state politicians been so unreceptive to such a patently good idea? Because politicians instinctively understand what most conventional economists don’t: the wisdom of Louis XIV’s finance minister’s declaration that “the art of taxation consists in so plucking the goose as to obtain the largest possible amount of feathers with the smallest possible amount of hissing”.
Or, to put it another way, because conventional economists don’t know enough behavioural economics – the study of how the world actually works thanks to human fallibility, rather than how it would work if we were all as rational as economic textbooks assume us to be.
A central element of the political economy of taxation is that what the punters don’t notice they don’t worry about.
And to every revenue-hungry state treasurer (which is all of ’em), the great virtue of conveyancing duty is that when you’re buying a place for $1 million and someone presents you with a tax bill for $40,000, it looks a relatively small amount and the least of your worries right now.
By contrast, when you open your mail one day and find the government demanding to be paid, say, $5000, you tend to get resentful. Because we’ve spent all our lives in a market economy, we’re used to the notion that, if you want something, you have to pay for it.
And with the converse: you don’t shell out good money without getting something you want in return. Annual land tax breaches that rule: you write a cheque for five grand and just post it off into the void. (This was also part of the reason the old “provisional tax” was so unpopular.)
Behavioural economists demonstrate empirically what politically astute treasurers know instinctively: you greatly reduce the hissing if you can whip the tax away without it being seen. This is why, when introducing the goods and services tax, Peter Costello wrote into the act the requirement that retail prices be quoted inclusive of the tax, without the tax being shown separately.
Of course, for wage earners, personal income tax has worked that way for decades. The pay office extracts an estimate of the tax you’ll have to pay and sends it to the taxman before you even see your pay.
After a while, you pretty much forget you’re paying tax on much of what you buy and are being paid much less than you’re earning. Which also demonstrates the wisdom of a saying familiar to treasurers: a new tax is a bad tax; an old tax is a good tax.
We object loudly to almost all proposals for new taxes – land tax on the family home, a road congestion tax and many more. We spent 25 years working up the courage to impose a value-added tax on “almost everything we buy” (during which time we copied the Kiwis’ crafty idea of renaming it the more innocuous “goods and services tax”).
But here’s the trick: once the new tax has been passed and taken effect, it takes only a year or two for us to accept it as part of the furniture. Behavioural economists call this quirk of human nature “status-quo bias”.
And, of course, just about the oldest tax of all is what Malcolm Fraser used to call “the secret tax of inflation” aka bracket creep.
It’s the tax increase you have when you don’t like tax increases.
Our “revealed preference” (not what we say, but what we do) is that bracket creep's our favourite tax.
Which is why treasurers of both colours give us so much of it.