U.S. Tax System is Full of Well-Known Marketing Gimmicks
ANN ARBOR -- As many Americans this time of year grapple with and grumble about one of life's more unpleasant certainties-taxes-most politicians want taxpayers to believe that the burden of paying Uncle Sam is small, say University of Michigan Business School researchers.
Consciously or not, designers of the U.S. tax system have applied what marketing researchers call the theory of price presentation—presenting prices for products in a way that reduces the perceived burden of spending—to the process of paying taxes, they say.
"In many ways, the U.S. tax system reflects the lessons of marketing research," says Joel Slemrod, U-M professor of business economics and director of the Business School's Office of Tax Policy Research. "The objective is not to increase purchases, but to reduce the perceived burden of the price or, in this case, tax. Holding constant the actual burden of taxation, most policy-makers would like to minimize the burden that taxpayers perceive."
In their study, "Behavioral Public Finance: Tax Design as Price Presentation," Slemrod and U-M marketing Prof. Aradhna Krishna present evidence about price presentation of consumer products and show how these lessons are reflected in the design of the U.S. tax system.
"The basic insight is that how a situation is framed can affect how people respond to it," Krishna says. "There is a vast amount of evidence that indicates that this is a ubiquitous phenomenon."
Krishna and Slemrod provide several examples of aspects of the U.S. income tax system, as well as in state and local tax regimes, that appear to reflect and perhaps take advantage of these behavioral patterns. These include:
- Discounts from a high base vs. penalties from a low base: Taxpayers are allowed to subtract exemptions and deductions (for dependent children, medical expenses, charitable contributions, etc.) from their baseline gross income—much like price discounts given by retailers.
"We could have a nearly equivalent income tax system that features a lower baseline tax liability, plus tax surcharges for those who are uncharitable, have low medical expenses, have few or no children, or are not blind or elderly," Slemrod says. "Of course, this idea that any given price should be framed as a discount to make the consumer believe he or she is getting a bargain or special deal is pervasive in marketing."
- Implications for sales tax: If sales tax is listed separately, consumers perceive that they are paying a lower price for a product and are more inclined to buy it.
"This suggests that there may be a conflict of interest between the government's price presentation objectives and those of the companies that sell products to consumers and, in many cases, remit the taxes to the government," Krishna says. "The government, to reduce dissatisfaction with taxes, would like the tax to be hidden in the final price, while the retailer would like the tax component to be separately identified."
- Pennies a day: Stating a continuing cost as a price per day rather than a price per month or per year is a common marketing phenomenon used to sell many kinds of products, including tax cuts.
"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," Slemrod says. "His framing effort was clear in comparison to referring to the Bush plan as a $1.6 trillion tax cut over 10 years."
- Discounting of future effort: The idea is that consumers buy goods with rebate coupons, then receive money back when they redeem the coupons.
"Non-redemption of consumer rebates is very high," Krishna says. "People don't anticipate that they won't bother—or forget—to apply for the rebate and are enticed to buy the product nevertheless. This phenomenon could be a factor in explaining the political support for targeted credits and deductions, if consumers fail to anticipate the effort involved in documenting the tax-favored activities."
- Price sales and tax sales: Sales promotions are so widely practiced that many consumers learn to purchase only when there is a price cut.
"Although there are analogies in the tax system to sales, it is certainly a less-used technique in that arena," Slemrod says. "Occasional, limited tax amnesties have the flavor of a sale, if not on the regular tax price, then on the penalty that ordinarily would accompany initially unreported tax liability."
- Effect of timing of rewards on incentives: In some situations, the overriding objective of price presentation in the tax system is to induce certain behaviors, such as with the earned income tax credit (EITC)—designed to encourage low-income people to work—or with savings incentives delivered through the tax system.
"Research suggests that the EITC should be paid out in real time rather than in a lump sum, because it is generally perceived as a better deal to segregate gains, although if tax credits are very small, they may not be viewed by taxpayers as being salient," Slemrod says. "A similar issue arises with respect to savings incentives delivered through the tax system, but lump-sum refunds may be better from a savings perspective, since there is evidence that people voluntarily save more from lump-sum payments."
- Percentage vs. absolute price contexts: Although the evidence is not clear on whether percentage (20 percent off) or absolute ($2 off) price promotion frames are better for presenting deals, research has shown that this aspect of framing matters in people's judgments about the appropriate degree of progressivity in the income tax.
"When people are asked what they think the 'right' amount of income tax should be at various levels of income, responses show a lower tax liability in dollars rather than in average or percentage terms," Krishna says. "This is consistent with the notion that the sacrifice of paying taxes becomes more palpable when the responses are measured in dollars, rather than the more abstract concept of average tax rates."
- 9 endings: Studies have shown that consumers perceive a substantially lower cost for a product with a price that ends in nine (e.g., $17.99), compared with one that is practically identical in price but ends in zero (e.g., $18.00).
"A policy-maker seeking to minimize perceived tax burden would be well-advised to take this lesson to heart," says Slemrod, who notes the top income tax rate of 39.6 percent until 2001 and the Medicare payroll tax rate of 2.9 percent as examples.
- Obfuscation: Research has shown that consumers pay little attention to the fine print and disclaimers in advertisements—much to the delight of marketers who may obscure information to paint a better picture of a product than what is the reality.
"Likewise, numerous features of the tax code, such as the phase-out of personal exemptions and itemized deductions, seem designed to substitute for more explicit and more transparent increases in tax rates," Slemrod says. "Arguably, their purpose is to confuse the true nature of how tax liability depends on income and other aspects of a taxpayer's activities."
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