After Tax: Taxation by way of Madison Avenue

Call it the pathetic period. That time after tax day when we take a deep breath and start glorying over the prospect of a refund. Somehow, we manage to forget that that refund was our money in the first place.

Two professors at University of Michigan have come up with an explanation for such tax docility. And the fact that one of them is a professor of marketing probably gives the whole story away.* Their position is a clear one: taxpayers will engage in a very unlovely activity - paying taxes - because it is made tolerable by that great prettifier of unlovelies: clever packaging.

Consider, for starters, a process most of readers have just completed: collecting deductions. When we spend our evening hours wondering about the home office - and what about that costly bookshelf? - that last charitable deduction, those stock market losses or how many kids we have, we are really cushioning ourselves from the pain of the tax take. Every deduction we uncover represents a small consolation.

This, the authors note, is exactly why the government does deliver the most painful punch first, and then moves to the deductions. It's a clever strategy. But it is important to remember that it was not always this way: when the first income tax form was created, in 1913, taxpayers calculated their tax and then reckoned their "super tax", the extra bit they paid in progressivity.

Government has learned a lot since then, and now plays the deductions game like Tiger Woods. And taxpayers have become addicted. So much so that going back to the old system of one simple rate, and few or no deductions is close to politically impossible, as the flat taxers can attest.

Another way lawmakers and the government trick the taxpayer is by finding ways to quantify taxes so they don't seem so high. "During the 2000 presidential campaign, Al Gore derided George W. Bush's tax cut plan on the grounds that the average family would get about enough money to buy one extra Diet Coke a day - about 62 cents," writes Joel Slemrod, an author of the study.

"His framing effort was clear in comparison to referring to the Bush plan as a $1.6 trillion tax cut over 10 years."

For European readers the trillion dollar number is particularly frightening, since it is larger than the scale of tax cuts that could be written in Europe. That, of course, is true because Europe's economies are not as big as that of the US. But few tax debaters on the international scene acknowledge this: they just use the T-word to demagogue for the argument that the cut is large.

Then there is the culture of the refund. Tax preparation firms have learned to arbitrage refunds lost by selling "fast rebates" or "instant rebates", especially to poorer members of society. What they neglect to highlight is that they charge sky-high rates of interest for providing this service, at something close to no risk to themselves. In other words, we treasure our consolation rebate so much that we are willing to pay even more for the pleasure of experiencing it.

But the largest tax marketing success of the past hundred years is that great beast, progressivity. Progressivity is so successful in part because most Americans don't understand it. People tend to confuse their "average rate" with their "marginal rate". Nobody wants to betray ignorance by raising the obvious question: is progressivity fair, or logical?

The real Madison Avenue-style genius, though, was in the term progressivity (instead of the old super tax or "graduated surcharge"). Progressivity sounds magnanimous.

The University of Michigan study provides food for thought on the dangers of the Value Added Tax, a system common in Europe but not in the US. The clever part of the VAT is that VAT taxes are collected at every stage of production, rendering them close to invisible. At the end, there is no VAT breakout, either. Most Europeans think a E5 item is a E5 item, without asking what part of that price is tax.

If you don't mind being manipulated like a laboratory rat, this all may be fine with you. But the marketing game has worked so well that it conceals the hidden economic dangers of our illogical tax apparatus. These days the big question on the economic table is whether the residential real estate market is overvalued, and set for the sort of massive correction equities have seen.

In tax terms, forecaster Brian Wesbury of GKST, the Chicago-based broker, says the answer would have to be yes. That is because homes are about the only area around that are tax-advantaged to the hilt. So citizens have invested (ie borrowed) beyond anything homes' true values can sustain, distorting, perhaps perilously. Alan Greenspan, Fed chairman, reinforced just this point in his testimony yesterday. the bedrock market on which consumer confidence rests.

And a Happy Tax Season to you, too.

* "Behavioural Public Finance: Tax Design as Price Presentation", by Aradhna Krishna and Joel Slemrod, University of Michigan

© Copyright 2002 Financial Times

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