Another argument for tax simplification


Will Wilkinson points to an American behavioural economist's hypothesis that the US's compex tax code might be contributing to people living beyond their means:

What are the consequences of knowing our gross yearly income and not much else? I think it causes us to feel richer than we really are and spend accordingly. Why would this be the case? There’s a phenomenon we call the “illusion of money,” which is the idea that we typically pay attention to nominal amounts of money rather than real amounts. For example, the illusion of money means that if inflation is 8%, and you get a 10% raise, you would feel better than if there was no inflation and you got a 3-4% raise. The basic idea is that we pay attention to the nominal amount rather than the purchasing power, and don’t realize what our money is really worth.In terms of our tax code, this suggests that in the US we focus on our gross yearly income, feel richer than we really are, and consequently end up spending more money.

I wouldn't be surprised if a similar phenomenon existed in the UK, thanks to the vagaries of national insurance, inflation and other stealth taxes, albeit to a lesser extent than in the US. This isn't helped by things like the tax credit system, which make things even more confusing and difficult to navigate. PwC says that household debt stands at around 110% of GDP, compared to around 63% of GDP in 1987.

I don't want to overstate the case – I'm sure historically-low interest rates and successive bubbles have a lot to do with this – but it seems likely to me that the complexity of the tax system might have contributed here, especially in terms of high-interest credit card debt, which a lot of people use to tide themselves over to the next pay day.

So, another argument for tax simplification. Maybe not the most important, compared with the disincentive to work that marginal taxation changes create and the cost of compliance that face firms, but it might resonate more with people concerned about the high household debt levels in this country. I'd like to see how household debt breaks down by socioeconomic group – I suspect that groups at the bottom of the pile tend to have a disproportionate amount of high-interest credit card debt. That would be a bad thing, and if it's partially caused by a confusing tax system, it's one that we could fix quite handily.