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What’s good about taxes?

April 5, 2011 1 comment

Few of us like paying taxes and most of us have blueprints for ideal tax systems in which we pay less. The message we send to our elected officials was summarized succinctly by Senator Russell B. Long: “Don’t tax you, don’t tax me, tax that fellow behind the tree!” Our distaste for taxes can be a force for bad, as when it drives us into hiding taxable dollars in offshore accounts. Yet it can also be a force for good, as when it drives us into saving for retirement. Debates about the relative tax benefits of Roth IRAs and regular IRAs often miss their most important benefit. Both Roth IRAs and regular IRAs harness our dislike of taxes into retirement savings.

Investment companies cater to our dislike of taxes. “Nowhere on any tax form does it say you can’t be crafty,” winks an advertisement by an investment company, offering tax-free mutual funds and the picture of a smiling man next to a swimming pool. “How to send less to the IRS,” promises an advertisement by another investment company.
High returns are the utilitarian benefits of tax-free funds; investors who send less to the IRS keep more of their investment returns. But tax-free funds, IRAs and 401(k) accounts have expressive and emotional benefits as well. We express ourselves as high-income investors, with status as high as our tax brackets. We express ourselves as smart, savvy, wily and crafty, which is what it takes to avoid taxes. Pride at avoiding taxes is emotionally satisfying, but the emotions accompanying taxes extend to anger and hatred. We are angry when taxes rob us of personal freedom or when they are wasted by politicians and bureaucrats. “Well, Mr. Big Brother IRS man, let’s try something different, take my pound of flesh and sleep well,” wrote Andrew Joseph Stack III in February of 2009, just before flying his plane into an IRS office building, killing an IRS employee and himself.

My mechanic sent a postcard offering “Tax Break Specials,” saving me the cost of sales taxes. He must know that his typical customers prefer small savings in the form of tax breaks to more substantial savings in the form of cash discounts. We dislike taxes so much that we are willing to forego $5,000 to save $4,000 in taxes. Here is an experiment by Abigail Sussman and Christopher Olivola.

Imagine circumstances where you earn an annual salary of $50,000 before taxes at an American company. Now pretend you are offered a position at one of two European branches at a $75,000 salary. The good thing about Country A is that your daily commute will be 60 minutes shorter than in Country B. The bad thing about Country A is that food would cost you $5,000 more than in Country B. Which country would you choose?

Now imagine identical circumstances except that the bad thing about Country A is that you would pay $4,000 more in taxes than in Country B. Which country would you choose? The first of the two circumstances was presented to one group of people and the second was presented to another group. It turned out that more people in the United States and Britain chose country B when they could save $4,000 in taxes than when they could save $5,000 in the cost of food.

We want to pay no taxes and the pain taxes is especially searing now, days before April 15th. May I alleviate your pain by reminding you that the pain of taxes drives you to greater savings for a more comfortable retirement?

Further reading

Abigail B. Sussman and Christopher Y. Olivola, “Axe the Tax: Taxes Are Disliked More than Equal Costs,” (presented at the 1st Annual Boulder Summer Conference on Consumer Financial Decision Making, June 27–29 2010).