Here’s a behavioral puzzler: Why might it be more efficient for Connecticut to change its sales tax rate from 6 percent to e^2 percent ?
Or more generally, why might using irrational numbers as tax rates be less distortionary than rational tax rates?
A hint comes from a great article by Amy Finkelstein, “E-ZTax: Tax Salience and Tax Rates.” Her simple and powerful idea is that as the salience of tax rates declines, taxes will produce fewer distortions because taxpayers will not pay as much attention to the taxes.
The E-ZPass system is a perfect context for her to examine this hypothesis because E-ZPass users (she finds) pay less attention to tolls than people who have to pony up the cash from their wallets or purses. Comparing E-ZPass highways to non-E-ZPass highways, she finds that as the proportion of drivers making electronic payments increases “toll rates are 20 percent to 40 percent higher than they would have been under manual toll collection.”
High salience prices can drive us crazy. Levitt has written that one reason the public was so upset about high gas prices was that they have to spend so much time standing at the pump and watching the higher price. High pump prices are the antithesis of EZ-Pass pricing.
The “out of sight, out of mind” effect suggests that policies to lower salience tax might reduce consumption distortions. I find it liberating to buy goods in foreign currency when I have difficulty converting the price into dollars. So to begin with, sales tax rates that are nice round numbers, like 10 percent, are likely to be more distortionary (than rates with many decimals) because it is so easy calculate the tax burden.
Taking this logic a step further leads to the perverse idea of using irrational numbers for tax rates. Since few Americans know that Euler’s number (e) is approximately 2.718, stating the sales tax rate in terms of e just might be lower salience. Classical economics would suggest that a tax rate of e^2 percent (approximately 7.39 percent) would produce higher distortions than a tax rate of 6percent because generally the higher the rate, the higher the dead weight loss. Finkelstein’s E-ZTax article makes me think that higher but less salient rates might be an exception to this rule.
By the way, there is no shortage of irrational numbers; there are an infinite number of irrational numbers between any two rational numbers.
Of course, as matter of political economy, we might as a society want to keep our taxes highly salient (even if it increases the dead-weight loss of taxes) to make sure that our representatives feel more constrained when deciding whether or not to hike our rates 20 to 40 percent.
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I appreciate your point on the way the mind functions – but as you mention in your final paragraph, I don’t think we should be looking for ways to make paying higher taxes more confusing to the public.
Why not 9.9%?
Looking prices in shops, this would be definitely efficient.
Or just omit the sales tax rate and amount from the sales receipts in the first place, and mandate the tax burden be incorporated into the selling price.
Now that I think about it, what would be interesting is continuously compounded interest at a rate of e%. That would give us future values of V = initial value * e^(e*time) … and what would happen if you taxed your gains at a rate of e^2?
not a very democratic post: confuse the masses so the vanguard can more effectively lead- the more ‘rational’ approach would be to have better civic education so that citizens would learn the maxim: everybody pays and everyone gets use
This is one of the reasons I REFUSE to get a EZ(Government Surveillance)-Pass or set up automatic bill payment. I want to be fully aware every time I am assessed a charge or fee so that I will be spurred to continually re-evaluate my economic choices. It is also the reason I tend to avoid smart card based transit cards that just need to be “tapped”.
This is also why I prefer to the common use of dollar bills over dollar coins. Paying with bills has higher salience than paying with coins. When I traveled to France about 15 years ago they had a handy 10 Franc coin and conveniently enough the price in most vending machines for a can of soda was 10 Francs. After a few days of casually feeding the machines I came to the realization that I was constantly paying $2 for 50 cent cans of soda!! I mean I was aware of the exchange rate, but plunking in one messily coin didn’t register as strongly had I been forced to feed in bank notes or multiple smaller denomination coins.
Shouldn’t this be a criticism, not a defense? If less salience is what you want, we shouldn’t have sales taxes at all. We shouldn’t even tax individuals. We should tax employers. We can have the IRS do all the math so that taxpayers wouldn’t be bothered with calculating their taxes. We can hide the formulas in vaults to which only the IRS has access.
People fear what they don’t understand.
Most people can’t even spell, much less figure out e^2.