Freakonomics Radio - 121. The Tax Man Nudgeth

Episode Date: April 3, 2013

Real tax reform may or may not ever happen. In the meantime, how about making the current system work a bit better?

From APM, American Public Media, and WNYC, this is Freakonomics Radio on Marketplace. Here's today's host of Marketplace, Sarah Gardner. It's Freakonomics time. Every couple of weeks, we talk to Stephen Dubner. He's co-author of the books and blog about the hidden side of everything. Stephen, it's good to talk to you. Great to talk to you, Sarah. Thanks for having me. It is April, which is every taxpayer's favorite month, of course. I thought today what we should do is take a look at the tax code we're stuck with for now and see if there are some improvements,

however slight, that we should be thinking about. Okay. So what kind of things are we talking about here? Well, one of the biggest failures of the current system is also the most obvious, which is that the IRS fails to collect a huge portion of the taxes that are levied, that are legitimately owed. So about 17% of the total tax bill, which is more than $450 billion a year. Whoa. Say that again. 17%. That's pretty astounding. It's a big number. It's called the tax gap. It's about $450 billion a year. The biggest contributor to this gap by far is very simple cash. It's all the cash that people earn and

simply don't report to the IRS. Austin Goolsbee was the top White House economist under President Obama. We asked him why the government doesn't go after all that easy money. Most of the non-collected money, for example, could be tracked and hunted down if you required small businesses to really report everything about their activity. But nobody wants to do that because that'd be so onerous and such a pain in the rear for small business owners that as a policy decision, they don't want to do it. So in other words, Stephen, politically, it's too dangerous. It'd be like the Small Business Harassment Act if they went after small businesses really hard.

Exactly. Even though these people are supposed to be paying taxes on that money. And even though, interestingly, the rest of us who don't pocket a lot of unreported cash, you know, we're subsidizing them. That's not to say that there aren't ways to nudge people to pay their taxes without hunting and tracking them down, as Austin Goolsbee says. One of my favorite examples of this comes from a small unit in the British government called the Behavioral Insights Team. And what they do is experiment with all kinds of cheap and simple nudges. For instance, sending out letters that appeal to the herd mentality in all of us. Here is the unit's director, David Halpern. So what we do is we simply tell people something which is true, which is nine out of 10 people in Britain pay their tax on time. And by putting that single bit of information into the top of

the letter, it makes people much more likely themselves to pay the tax on time. So it's peer pressure. It's exactly right. We like to run with the herd. They also tried another super simple trick, which was just handwriting a message on the outside of the tax envelope. This message would just say simply that the contents are important, but it's written in hand. Of course, people are like, oh my God, but how can that possibly be practical? Well, we've now just got the results in. It turns out that for every pound or every dollar that you spend on getting someone to write on the envelope, you get $2,000 return, the $1,000 to $2,000

return. So it's a nice, simple illustration of these small things and how consequential they are. So it sounds like peer pressure and the personal touch, those aren't bad ideas, really. They're great ideas. They're small. They're on the margin. They also have the collective result of trying to make taxpaying a little bit more, I don't know, fun is the right word. But, you know, the way the tax system is currently set up, we see paying taxes as pure downside, right? Not only does it cost us money, but it's on top of that, it's complicated. It gives us angst. And maybe worst of all, any given person has practically no say in how your hard-earned tax dollars are actually going to be spent, right?

So Dan Ariely, who's a behavioral psychologist at Duke, he has a nice idea. It's to let taxpayers direct a small portion of their tax money to the parts of the government that they most care about. So I'm not sure what's the right percent, 5 percent, 10 percent. But what if we got people to have a say about where some of the taxes go? All of a sudden, you're not looking at it as you against the government. You'd have to look carefully at all that the government is doing for us, building libraries and roads and education and military and so on and so forth and say, what do I care about? I don't know about that. I mean, what do you think? It would be fascinating to see

how many people would really want to say, gee, I want to put more money into defense or Medicare. But a lot of military families out there who really feel like the military gets the short shift. That's the thing. But you're right. The first thing you said, I absolutely agree with. We don't really know because we've never really asked and we've never really given the opportunity for people to say. So, Stephen, what about you? Where would you put your 5 or 10 percent? Oh, I think that's pretty obvious there, don't you think? I'd send it to a slush fund for people who make radio about economics. Oh, okay. Stephen Dubner, our Freakonomics correspondent. He puts out a podcast, too.

You can get that on iTunes and hear more at Freakonomics.com. Stephen, it has been a pleasure. Thank you so much. Bye-bye. Hey, podcast listeners, you heard a little bit in this episode from David Halperin, who runs the British government's behavioral insights team. They are more informally called the Nudge Unit after the book Nudge by the American academics Richard Thaler and Cass Sunstein. Halpern himself is an academic, very well regarded. And it's encouraging, to me at least, to see him putting so many academic ideas to work in a government job. So let's hear a little bit more from our interview with Halpern.

Here he is talking generally about the nudge unit's mission. Well, we think that if you have a more nuanced understanding of how people actually make decisions or what drives behavior, you can design policy that's better, it's cheaper, it's easier, it's more effective for people. So, for example, people often worry about, you know, how we can use a tax subsidy to get more people in employment or saving or whatever it will be. We're obsessed about the tiny details. We're obsessed about the little inconveniences and hassles that get in the way of people being able to do things, which maybe have traditionally got a lot less attention. Not only because, you know, they can often be annoying for citizens, but if you can get rid of those frictions, those details, those problems, everything works better.

So the nudge unit nudges people with experiments, with clever incentives, often in areas that most of us don't give much thought to. Attics, for instance. One nice one we tried may appeal to people over there is that very large numbers of people haven't insulated their homes enough in Britain. And even though for years we offer great big subsidies to encourage people to insulate their home, the thing about this is it's a no-brainer right as we would say you know you get your money back in the first year so why don't people insulate their lofts their attics I guess you'd call and of course when you're looking into the reason why most people don't do it is because their attics full of stuff they should have thrown out years ago and that's the real reason so giving them ever bigger subsidies doesn't really work very well. So we ran a trial instead by offering people an attic clearance scheme,

which, by the way, they have to pay for, but it's fine. And we found that that increased by three to five-fold the uptake of people getting their attics insulated. And it didn't require more money or subsidy from government. It just required offering the service in a way which was convenient for people. Maybe it's just his accent. I don't know. But Halpern strikes me as quite clever, maybe also wise. And there's the novelty of hearing about a government

trying to make life simpler for its citizens rather than more complicated. Well, I hope for many people their experience of this will ultimately is, it'll just be easier, just life will be easier. Instead of thinking of your taxes as, I mean, fine, no one wants to pay their taxes, probably, right? But at least let's make it as easy as possible and as frictionless as possible, and you get letters which are tailored to you and so on. So you'll get a sense of government which is really efficient and effective in the way it operates, in its details. And that's true, of course, particularly around big areas of policy,

be it from, you know, boosting economic growth or improving fuel efficiency or a million other things. So that was David Halperin from the British government's behavioral insights team. Coming up on the next Freakonomics Radio, we ask a seemingly simple question. How much does your name

really matter from the unusual names? Can you give us your full name? Yeah, sure. Yao, Xing, Haino, Augustus, Eisner, Alexander, Weiser, Knuckles, Jermajenko, Connolly. To the black and white names. Molly, Madeline, Caitlin, and Emma. Imani, Ebony, Precious, Deja, Diamond.

To the red and the blue names. In the conservative house, the girls would have names like Casey, McKenzie, Jordan, Taylor, and Sarah. In our liberal house, they would have names like Lola, Mia, Thea, Eliana, and Ruby. Everybody's got a name. What does yours say about you?

That's next time on Freakonomics Radio.