Sunday, 18 May 2014

Unpopular Taxation As a Master Stroke for Reduced Tax Pressures?

A new paper by LSE economists estimates levels of tax fraud in the UK before and after the late Margaret Thatcher's hugely unpopular poll tax, which was levied in large part independently of payer's income and lasted from 1990 to 1992. The picture that is worth  a thousand words (click to enlarge):
Tax evasion here means the share of tax liabilities not paid, calculated on the basis of independently-assessed property valuations. The figure shows averages from British councils. Before and after the poll tax, rates were levied based upon valuations of payers' accommodation. I know too little about the differences between these systems to be able to tell, but I suppose there might be some subtle difference in the systems which could be behind some of the discovered change (I have not read the paper very carefully).

But the figure is very interesting. The trend went towards lower levels of tax evasion before and after the poll tax years. This trend was resumed after its abolition, but from a higher level. The authors argue that this is due to a norm establishing itself to the effect that "one ought to pay one's taxes". This norm suddenly became expensive to a significant fraction of citizens, and their evasion had ring-effects which further eroded the norm.

Norms and habits are often analysed as separate phenomena, but this illustrates a link between them. Person A pays most of his taxes in part because others do. In the aggregate, this looks like habit persistence. But a small but sufficient increase in the "price" of the "habit" can result in great decreases in tax compliance. This does not in any way show that norms and habits are inextricably linked, only that it may not always be that easy to tell which factor is the operative one.

This, however, is very much an aside. If unpopular taxation can lead to more tax evasion, it is an interesting potential trick for those wishing to ease the tax burden without sounding too radical. Simply think of some horrendously insane tax and introduce it. The effects of this may be good or bad, but it is an interesting strategy. However, the unpopularity that comes with a tax like this makes it a sure-fire election loser for anyone who tries this strategy. Just like what happened to the Iron Lady.

The results remind me of what Milton Friedman used to argue was a drawback of heavy-handed government: That resultant crazy legislation erodes respect even for sane legislation. I have always been a keen admirer of Milton Friedman's, but I have never put too much stock into this argument, simply because I don't think anyone is likely to think murder is less wrong because, say, avoiding compulsory military service is also punishable. But maybe some version of Friedman's argument has more merit than what first meets the eye (or met my eye, anyway).

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