The Pain of Paying Taxes

Abstract

Behavioral economists have shown that spending money imposes a psychological cost—the pain of paying. This Article argues that the pain of paying has significant implications for our tax system that have escaped the attention of legal scholars, economists, and policymakers. With a few caveats, standard economic models assume that, from society’s perspective, the payment of a tax constitutes a costless transfer from the taxpayer to the government. The financial loss to the taxpayer is exactly offset by tax revenue, allowing the government to pay for beneficial public goods. The standard view, however, ignores the psychological burden imposed by revenue collection. Because the pain of paying reduces social welfare, a strong case exists for designing taxes in a way that minimizes it. Doing so is possible because the pain of paying varies in predictable ways depending on situational factors such as the method of payment. Moreover, policymakers can potentially reduce the pain of paying by clearly linking tax payments to the receipt of government benefits.

The Article argues that the pain of paying supports a variety of tax reforms, including return-filing simplification efforts and greater reliance on user fees, earmarked taxes, and even lotteries. In addition, the pain of paying has profound consequences for democracy. Because tax payments are not tightly connected to the receipt of government benefits, the pain that they cause is almost certainly exaggerated in the minds of voters. This helps explain an enduring mystery of American democracy: Americans strongly support virtually all government programs, but they oppose the taxes necessary to pay for them. As a result, popular programs such as Social Security and Medicare are at risk for draconian cuts. Better understanding the pain caused by paying taxes and the techniques for mitigating it will help policymakers overcome anti-tax sentiment and raise the revenue needed to fund the programs that voters claim they want.

Keywords: tax, pain of paying, law and psychology, behavioral economics

JEL Classification: H21, H23, K34