Taxing Nudges

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 is 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

User-Friendly Taxpaying

Technology is revolutionizing our lives. With the touch of a button or a simple voice command, we can instantly order groceries, get directions, or find the nearest sushi restaurant. Sensibly, the private sector has capitalized on these recent innovations to drive up profits. To sell more laundry detergent, Amazon now enables consumers to order refills by simply pressing the “dash button” mounted above their laundry machines. Starbucks lures more customers by allowing them to pre-order online and have their drink waiting when they arrive at the store. The theory behind this approach is simple: if you want someone to use your product or service, you should make it as quick and easy as possible for them to do so. This Article makes a novel argument to extend this line of reasoning to encourage better compliance with the tax laws. In making this argument, the Article draws upon behavioral science research showing that complexity impacts individuals’ decision making and encourages dishonesty. The Article then offers a number of proposals for how policy makers could simplify individuals’ interactions with the tax system. For example, the IRS could allow taxpayers to easily record their income and deductions online during the year using smart phones or tablets. Those items could be stored in an online personal taxpayer account and, at the end of the year, automatically uploaded to an electronic return. Easing the burden of taxpaying should encourage more taxpayers to report honestly, in addition to reducing their compliance costs. In the same way that designing products or websites to be user-friendly encourages their use, making the tax system more user-friendly should attract more voluntary participatio

The Modern Case For Withholding

Who is responsible for paying taxes to the government? Currently, the answer depends on one’s employment status. Employees enjoy the luxury of not having to think about tax remittance during the year because their employers withhold taxes from their paychecks. Non-employees, on the other hand, face a much more onerous system. They must keep track of and budget for taxes during the year, make quarterly remittances to the IRS, and may face penalties for failing to do so. Although this regime has been in place for many decades, there are several reasons why reform may be in order. First, the independent contractor workforce is expanding, propelled in large part by the growth of the gig economy. This means an increasing number of taxpayers are earning income outside of employment that is not captured by withholding. Second, the rise of the internet and other advances in technology have made withholding by third parties more efficient and less costly than was historically the case. Finally, advances in the social sciences have shed new light on why many taxpayers appear to prefer withholding and why it may serve to enhance overall welfare. Accordingly, this Article proposes an expanded withholding regime that would condition withholding on the size of the business making the payments, rather than on the business’s status as an employer. Under such a regime, any business earning over a certain threshold that pays more than a de minimis number of workers would be required to withhold taxes. To address cases where withholding would not be feasible, this Article also introduces the concept of “quasi-withholding.” Quasi-withholding would interject a private third party between the taxpayer and the IRS to facilitate tax payments and replicate the benefits associated with withholding. The third party could be a financial institution or a private business formed specifically to assist with tax remittance. Expanding withholding would vastly simplify the tax system for taxpayers, while enhancing revenue collection for the government, presenting a rare “win-win” opportunity for tax reform