Sunday, August 17, 2014

Is Tax Complexity Discriminating Against Dumber People?

New research out of Harvard that is very disturbing (although probably not surprising).

  • To control for the weirdness of the real world, they did this as a lab experiment. In these experiments, subjects enter for free and play for real money that is proportional to their performance.
  • They simulated taxes. Subjects got to keep the after-tax money they earned.
  • They did this with the same people in two environments: one in which taxes were simpler (had less rules to follow) and one in which they were more complex (had more rules to follow). The subjects’ outcomes would be the same across the two environments if they were able to follow all the rules.
  • They found that subjects behavior was closer to optimal when the tax system was simpler. Basically, subjects left money on the table when the tax system was too complex.
  • It gets worse. Then they added an identical rule to each tax system — making each setup a little more complex — and had the subjects play again. Now, put on your thinking caps: in the simpler system, the marginal increase in complexity from an identical change will plausibly be larger. What they did was actually go from 2 to 3 tax rules, and from 22 to 23 tax rules, so this seems like a plausible conclusion. What they found was that performance went down under both systems, which isn’t very surprising. What is surprising is that they found that 1) performance got “more worse” (I know that sounds kludgy) with the complex system, 2) poorer performance was concentrated in the people who performed worse before the change, and 3) the measured decision-making time of those people didn’t change much.

The authors conclude from this that they were able to isolate subjects who found the complex system to be beyond their cognitive ability, and that when confronted with a rule change that made that problem worse, these people shut down and ignored the change.

This is a strong case that a complex tax system discriminates against people on the lower end of the intelligence spectrum.

That’s a bombshell: politicians, in collusion with bureaucrats, accountants and lawyers, may have set up systems that discriminate against people who aren’t as smart as they are.

Keep this research in mind the next time someone tells you that a flat tax system is bad, or that a progressive tax system is better.

BTW: In perusing the reference list, I conclude that the strain of literature these authors are targeting is liberal rather than conservative: it falls in the Elizabeth Warren, Cass Sunstein orbit of the Democratic party.

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