The Tax Man Nudgeth: A New Marketplace Podcast

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Our latest Freakonomics Radio on Marketplace podcast is called “The Tax Man Nudgeth.”  (You can download/subscribe at iTunes, get the RSS feed, listen via the media player above, or read the transcript.)

The U.S. tax code is almost universally seen as onerous and overly complicated. There is always talk in Washington about serious reform — Michigan Reps. Dave Camp (R.) and Sander Levin (D.) are currently working on it — but, Washington being Washington, we probably shouldn’t hold our breath.

So in this podcast we decided to take a look at the tax code we’re stuck with for now and see if there are some improvements, however marginal, that are worth thinking about. We start by discussing the “tax gap,” the huge portion of taxes that simply go uncollected for a variety of reasons. We once wrote about a clever man who helped close the gap a bit. In this episode, former White House economist Austan Goolsbee tells us why the government doesn’t try too hard to collect tax on all the cash that sloshes around the economy.

You’ll also hear from Dan Ariely, who has an idea for turning the act of paying taxes into a somewhat more satisfying civic duty.

And we learn how a tiny British Government unit, the Behavioral Insights Team, is using the latest academic findings in behavioral economics and psychology to nudge British taxpayers toward compliance. The B.I.T. is informally called the “Nudge Unit,” after the excellent book Nudge by Richard Thaler and Cass Sunstein. Thaler regularly consults for the unit; Sunstein, who recently exited government service here in the U.S., has just written a related book called Simpler: The Future of Government.

In the podcast, you’ll hear from the Nudge Unit’s director, David Halpern, a noted social scientist himself and the author of an excellent book called The Hidden Wealth of Nations. While the Marketplace segment only had room for a couple of clips of our Halpern interview, this podcast includes an extended cut of him talking about a number of other, non-tax measures. I hope you find it as interesting as I did.

Audio Transcript

Sarah GARDNER: It’s Freakonomics time. Every couple weeks, we’re talking with Stephen Dubner, co-author of the books and blog about “the hidden side of everything.” Stephen, it’s good to talk to you.

 

Stephen J. DUBNER:  It’s great to talk to you, Sarah.  Thanks for having me.  It is April, which is every taxpayer’s favorite month, of course.  I thought today what we should do is take a look at the tax code we’re stuck with for now and see if there are some improvements, however slight, that we should be thinking about.

 

GARDNER: OK.  So what kind of things are we talking about here?

 

DUBNER: Well, one of the biggest failures of the current system is also the most obvious: the I.R.S. fails to collect a huge portion of the taxes that are levied -- that are legitimately owed.  So about 17 percent of the total tax bill, which is more than $450 billion a year.

 

GARDNER: Whoa!  What?  Say that again.  17 percent!  That’s pretty astounding.

 

DUBNER: It’s a big number.  It’s called the “tax gap.”  It’s about $450 billion a year.  The biggest contributor to this gap, by far, is very simple -- cash.  It’s all the cash that people earn and simply don’t report to the I.R.S. Austan Goolsbee was the top White House economist under President Obama. We asked him why the government doesn’t go after all that easy money.

 

Austan GOOLSBEE: Most of the non-collected money, for example, could be tracked and hunted down if you required small businesses to really report everything about their activity. But nobody wants to do that because it would be so onerous and such a pain in the rear for small business owners that, as a policy decision, they don't want to do it.

 

GARDNER: So, in other words Stephen, politically it’s too dangerous.  It’d be like “The Small Business Harassment Act” if they went after small businesses really hard.

 

DUBNER: Exactly.  Even though these people are supposed to be paying taxes on that money.  And even though, interestingly, the rest of us, who don’t pocket a lot of unreported cash -- we’re subsidizing them.  That’s not to say there aren’t ways to nudge people to pay their taxes without “hunting and tracking them down,” as Austan Goolsbee says. One of my favorite examples of this comes from a small unit in the British government called the Behavioral Insights Team.  What they do is experiment with all kinds of cheap and simple nudges.  For instance, sending out letters that appeal to the herd mentality in all of us. Here is the unit’s director, David Halpern:

 

David HALPERN: So what we do is we simply tell people something, which is true, which is 9 out of 10 people in Britain pay their tax on time. And by putting that single bit of information into the top of a letter, it makes people much more likely themselves to pay the tax on time.

 

GARDNER: So it’s peer pressure?

 

DUBNER: That’s exactly right -- we like to run with the herd.  They also tried another super simple trick, which was just handwriting a message on the outside of the tax envelope.  This message would just say simply that the contents are important, but it’s written in hand.

 

HALPERN: Of course people are like ‘oh my God, but how can that possibly be practical?’ Well we’ve now just got the results in. It turns out that for every pound or every dollar that you spend on getting, you know, someone to write on the envelope, you get $2,000 return.  A one to 2,000 return. So it’s a nice simple illustration of these small things and how consequential they are.

 

GARDNER: So it sounds like peer pressure and the personal touch.  Those aren’t bad ideas, really.

           

DUBNER: They’re great ideas.  They’re small.  They’re on the margin.  They also have the collective result of trying to make tax paying a little bit more, I don’t know if fun is the right word.  But the way the tax system is currently set up, we see paying taxes as pure downside. Right?  Not only does it cost us money but on top of that, it’s complicated, it gives us angst.  And, maybe worst of all, any given person has practically no say in how your hard-earned tax dollars are actually going to be spent.  Right?  Dan Ariely, a behavioral psychologist at Duke, has a nice idea: to let taxpayers direct a small portion of their tax money to the parts of the government that they most care about:

 

Dan ARIELY: So I’m not sure what’s the right percent -- five percent or ten percent.  But what if we got people to have a say about where some of the taxes go? All of a sudden you’re not looking at it as you against the government.  You’d have to look carefully at all that the government is doing for us -- building libraries and roads, and education and military and so on and so forth and say, what do I care about?

 

GARDNER: I don’t know about that!  It would be fascinating to see how many people would really want to say, ‘gee, I really want to put more money into defense.’  Or Medicare.  You know?

 

DUBNER: A lot of military families out there feel like the military gets the short shrift.  But the first thing you said -- I absolutely agree with.  We don’t really know, because we’ve never really asked and we’ve never really given the opportunity for people to say.

 

GARDNER: So Stephen, what about you?  Where would you put your five or ten percent?

 

DUBNER: Oh, I think that’s pretty obvious, Sarah, don’t you think?  I’d send it to a slush fund for people who make radio about economics. 

 

GARDNER: Oh, OK!  Stephen Dubner, our Freakonomics correspondent. He puts out a podcast, too -- you can get that on iTunes and hear more at Freakonomics dot-com.  Stephen, it has been a pleasure.

 

DUBNER: Thank you so much.

 

[MUSIC]

 

DUBNER: Hey podcast listeners. You heard a little bit in this episode from David Halpern, who runs the British government’s Behavioural Insights Team. They are more informally called the “Nudge” Unit, after the book Nudge by the American academics Richard Thaler and Cass Sunstein. Halpern himself is an academic, very well-regarded, and it’s encouraging -- to me, at least -- to see him putting so many academic ideas to work in a government job. So let’s hear a bit more from our interview with Halpern. Here he is talking generally about the Nudge Unit’s mission:

 

HALPERN: Well, we think that if you have a more nuanced understanding of how people actually make decisions or what drives behavior, you can design policy that’s better, it’s cheaper, it’s easier, it’s more effective for people. And so for example, people often worry about, you know, how we can use a tax subsidy to get more people in employment or saving or whatever it will be. We’re obsessed about the tiny details. We’re obsessed about the little inconveniences and hassles that get in the way of people being about to do things, which maybe traditionally got a lot less attention not only because they can often be annoying for citizens, but if you can get rid of those frictions, those details, those problems, everything works better.

 

DUBNER: So the Nudge unit nudges people -- with experiments, with clever incentives, often in areas that most of us don’t give much thought to. Attics, for instance.

 

HALPERN: One nice one we tried may appeal to people over there is that very large numbers of people haven’t insulated their homes enough in Britain.  And even though for years we offer great big subsidies to encourage people to insulate their home, the interesting thing about this is it’s a no-brainer as we would say. You know, you get your money back in the first year, so why don’t people insulate their lofts? Their attics I guess you’d call them. And of course when you look into the reason why most people don’t do it is because their attic’s full of stuff that they should have thrown out years ago. And that’s the real reason. So giving them ever bigger subsidies doesn’t work very well. So we ran a trial instead by offering an attic clearance scheme, which by the way they have to pay for, but it’s fine. And hey, we found that that increased by three to five-fold the uptake of people getting their attics insulated. And it didn’t require more money or subsidy from government, it just required offering this service in a way which was convenient for people.

 

DUBNER: Maybe it’s just his accent, I don’t know. But Halpern strikes me as quite clever, and also wise. Also, there’s the novelty -- of hearing about a government trying to make life simpler for its citizens rather than more complicated:

 

HALPERN: Well I hope for many people their experience for this ultimately is it will just be easier, just life will be easier. Instead of thinking of your taxes as, I mean, fine no one wants to pay their taxes probably, right? At least let’s make it as easy as possible and as frictionless as possible. And you get letters which are tailored to you and so on. So you’ll get a sense of government, which is really efficient and effective in the way it operates in its details. And that’s true of course   particularly around big areas of policy be it from, you know, boosting economic growth or improving fuel efficiency, or a million other things.”

 

[MUSIC]

 

DUBNER: So that was David Halpern from the British government’s Behavioral Insights Team. Coming up on the next Freakonomics Radio, we ask a seemingly simple question: how much does your name really matter? From the unusual names:

DUBNER: Can you give us your full name?

YO: Yeah, sure. Yo Xing Heyno Augustus Eisner Alexander Weiser Knuckles Jeremijenko Conley.

DUBNER: To the black and white names:

SWEENEY: Molly, Amy, Madeleine, Caitlin and Emma.//Imani, Ebony, Precious, Deja, and Diamond.

DUBNER: To the red and blue names

OLIVER: In the conservative house the girls would have names like Casey, McKenzie, Jordan, Taylor and Sarah. In our liberal house, they would have names like Lola, Mia, Thea, Eliana, and Ruby.

DUBNER: Everybody’s got a name. What does yours say about you? That’s next time on Freakonomics Radio.

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COMMENTS: 15

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  1. frankenduf says:

    we should have an automated tax system, where the gov’t computes/executes the taxes for u, so the majority of taxpayers doesn’t have to go thru the rigamarole- the only downside would be that hr block goes belly up- but that’s just a matter of time due to quicken…

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  2. Brit says:

    @frankenduf: Well, that’s a nice idea, but HR Block and Quicken would oppose that simplification. There was a recent report from Propublica showing that Intuit (maker of TurboTax) has spent millions preventing the US government from creating online automated systems to help people file taxes. Any simplification of the tax system will be opposed by the businesses that gain from a complicated tax system.
    http://www.propublica.org/article/how-the-maker-of-turbotax-fought-free-simple-tax-filing

    If you’d like to see some of this propaganda paid for by Intuit:

    “WHAT IS THE STOP IRS TAKEOVER CAMPAIGN?”
    “The Stop IRS Takeover Campaign is fighting to stop the massive expansion of the U.S. government through a big government program called “Simple Return,” “Return Free” or “Ready Return.” Advocated by the White House and soon to be introduced to Congress, a “Simple Return” system will give power to the IRS to not only collect your taxes, but also prepare your taxes – “for free” – and send you the bill.”

    They’re positioning any simplication or online tax preparation as “big government takeover”.

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    • James says:

      While the automatic return might work for people who just have income from wages, I can’t see it becoming practical for a lot of us. Even assuming the IRS could track my spending, how could it determine whether each purchase is a business expense (thus deductable on my Schedule C, or how much of the money I spend at Home Depot can be deducted on Form 8829 (Business Use of Home)?

      The other half of the question is why all those wage-only taxpayers think it’s so darned complicated to fill in a 1040-EZ or 1040-A.

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      • Seminymous Coward says:

        Perhaps it’s considered hard because my 1040A was accompanied by 3-4 schedules, forms, riders, or whatever. Alternatively, it could be that the penalty for a wrong answer to any of the questions can be huge financial penalties, a tactical entry by IRS-CI, or a felony conviction. I think the core, though, is the tortured definitions of seemingly plain terms.

        Also, as a practical matter for someone who is not an expert in the process, you need to fill out a 1040 to see if you should submit it, a 1040A, or a 1040EZ, since otherwise you risk paying more tax than required.

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      • James says:

        Most of those additional schedules are fairly simple. I typically file Schedules A, B, C, D & SSE, of which only C (and attached form 8829) are any difficulty at all, and that’s only because I need to sort through the year’s shoebox of receipts.

        As for penalties, the response to a wrong answer (as opposed to deliberate fraud) is generally a refund check or a polite note asking for a few more dollars. I honestly think most people pay more for tax preparation fees than they’d risk paying in penalties if they did their returns themselves.

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      • Brit says:

        It seems like you’re responding to a different question. There’s two questions here: can the Federal government automatically calculate your taxes with little/no input from the taxpayer (probably not), and the second question of whether the government could setup online tax-paying systems (like Denmark, Sweden, and Spain). You seem to be responding to the first question. I’m saying that existing tax-preparation businesses (HR Block, Intuit, etc) would oppose both.

        I also think it’s an important point to make that businesses will both oppose more efficient government and promote the idea of inefficient government as a way of protecting their own revenue.

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  3. Scott says:

    Great podcast as usual. I totally agree with having taxpayers determine which departments receive their tax dollars at both the state and federal level. I live in Arizona and there are state tax credits for schools and working poor. If you donate a certain amount ($200 for individuals, $400 for married couples) to a qualified organization, you get a credit that offsets your income tax (link to website for tax credit for working poor – http://www.azdor.gov/TaxCredits/WorkingPoorTaxCredit.aspx). Since I feel that Arizona is doing a very poor job of providing funds for education and the working poor, the last few years I have directed almost all of my income tax to both a public school and a non-profit organization that provides support for the working poor. It has actually made me feel good about paying my taxes because I know where my tax dollars are going. Perhaps the model in Arizona could be studied to understand the impact and whether is would be beneficial to roll out similar programs out to other states and the federal level.

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    • Enter your name... says:

      I do this mentally most years. If a government agency or person does a great job, then I tell myself that supporting that action is what my money paid for this year. It doesn’t have any practical effect (and it won’t, in the long run, because they’ll be able to guess how much people will ‘donate’ to which agencies, and reduce their normal budget to account for it), but it’s definitely satisfying.

      Once, I witnessed an Air Force officer driving two hours away to pick up a woman whose car broke down on a family trip while her husband was deployed. He fixed the car on the side of the highway and made sure she got home safely. I immediately “earmarked” my tax dollars for his salary that year.

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  4. Carlos says:

    Hi Stephen, the podcast was interesting, but I was expecting a little more… a real solution that would make the audience think, remember and react. If the government wants to close the tax gap, then, they will have to seriously look into eliminating the income taxes and replacing them with sales and luxury taxes.

    It would be interesting if you could do anther podcast about the sales and luxury taxes. I’d like to hear what Steven Levitt has to say about it.

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  5. Chris Burke says:

    I read an ebook a couple of years ago entitled If I Were King that promotes a progressive consumption tax in lieu of income and payroll taxes. The basis of the tax is that the more a product or service costs the higher the tax rate. This would eliminate the inherent regressive aspect of either a flat income tax or a standard value added tax and would address the wealth gap and not just the income gap that is a pall over the economy. The book also suggests a similar tax for the corporate world as well.

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  6. Caleb B says:

    As a former waiter, every person in my restaurant claimed 11% in tips. The credit cards were automatic, so you had to claim 100% of credit cards, but you’d adjust your cash tips so you always came out at 11%. My manager said it was because if the restaurant’s report said 10% or lower, it would trip a trigger and they’d get audited.

    I’ve always wondered if the IRS was ever curious why no waiter in America made more than 15% in a year.

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    • Brit says:

      > “I’ve always wondered if the IRS was ever curious why no waiter in America made more than 15% in a year.”

      I’d bet that the IRS knows that waiters are under reporting their tips. The problem probably has more to do with figuring out what the real number is and the difficulty of cracking down on people who probably aren’t earning that much money to begin with (i.e. blood from a stone).

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  7. Leslie says:

    Another area of lost income and potential tax to the IRS is in the rule that says if an independent contractor makes less than $600 the reporting business does not have to file a Form 1099-MISC with the IRS. The onus is now on the independent contractor to claim the income – or not. If you add up all the income that falls below the threshold of $600 I bet there is a fair amount of coin there. Sort of like the fraudster that figured out if every bank transaction included $0.o1 for his personal account he could be rich. He made millions.

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  8. Al says:

    The concept of the “tax gap” presupposes that taxation is legally and more importantly morally valid. There is a debate on whether federal income tax is valid on the grounds that the 16th Amendment was never properly ratified. Also, since the government interferes with private transactions, one could say that taxation is equal to theft and therefore immoral. The only way to make taxation moral is to make it optional. That would at least solve the problem of the “tax gap.” :)

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