Taxing Nudges

60 Pages Posted: 4 Mar 2020 Last revised: 17 Mar 2020

See all articles by Kathleen DeLaney Thomas

Kathleen DeLaney Thomas

University of North Carolina School of Law

Date Written: February 25, 2020

Abstract

Governments are increasingly turning to behavioral economics to inform policy design in areas like health care, the environment, and financial decision-making. Research shows that small behavioral interventions, referred to as “nudges,” often produce significant responses at a low cost. The theory behind nudges is that, rather than mandating certain behaviors or providing costly economic subsidies, modest initiatives may “nudge” individuals to choose desirable outcomes by appealing to their behavioral preferences. For example, automatically enrolling workers into savings plans as a default rather than requiring them to actively sign up has dramatically increased enrollment in such plans. Similarly, allowing individuals to earn “wellness points” from attendance at a gym, redeemable at various retail establishments, may improve exercise habits.

A successful nudge should make a desired choice as simple and painless as possible. Yet one source of friction may counteract an otherwise well-designed nudge: taxation. Under current tax laws, certain incentives designed to nudge behavior are treated as taxable income. At best, people are ignorant of taxes on nudges, an outcome that is not good for the tax system. At worst, taxes on nudges may actively deter people from participating in programs with worthy policy goals. To date, policymakers have generally failed to account for this potential obstacle in designing nudges.

This Article sheds light on the tax treatment of nudges and the policy implications of taxing them. It describes the emergence of a disjointed tax regime that exempts private-party nudges but taxes identical incentives that come from the government. What’s more, an incentive structured as a government grant may be taxable while an economically identical tax credit is not. The Article then proposes reforms that would unify the tax treatment of nudges and enhance their effectiveness. Specifically, lawmakers should reverse the default rule that all government transfers are taxable, and instead exclude government transfers from income unless otherwise provided by the Tax Code.

Keywords: tax, taxation, tax policy, behavioral law and economics, nudges

JEL Classification: E62, H20, H21,H22, H24, H25, H26, H29, H30, K34, A12, K42, K34, O33, O35, O38, J38, J30

Suggested Citation

Thomas, Kathleen DeLaney, Taxing Nudges (February 25, 2020). Virginia Law Review, Forthcoming. Available at SSRN: https://ssrn.com/abstract=3544263 or http://dx.doi.org/10.2139/ssrn.3544263

Kathleen DeLaney Thomas (Contact Author)

University of North Carolina School of Law ( email )

Van Hecke-Wettach Hall, 160 Ridge Road
CB #3380
Chapel Hill, NC 27599-3380
United States
919-843-7630 (Phone)

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