Taxes and happiness
It is early April and here in the UK, a new tax year has begun. And that means that soon, we will all be thinking about filling out our tax returns, though most people will inevitably delay it as far in the future as possible. Nobody likes to pay taxes and we all could do with less than what we pay today.
Yet, if you ask people how unhappy they would be if income taxes were increased, most people vastly overestimate the negative impact higher taxes would have on their happiness. It is a little bit like asking people how unhappy they think they would be if they had an accident that paralysed them. Most people would think they’d be desperately unhappy, but if you ask real-life paraplegics, it turns out there is no difference in their general level of happiness before and after their accidents.
This brings me back to taxes (not that taxes are a paralysing accident, though). A 2018 study of individuals in the United States investigated the relationship between income taxation, income inequality, and happiness. The study focused mostly on progressive taxation and its correlation with happiness and found that in a more progressive tax system where higher income groups are taxed more aggressively, there is a similar difference between perception and reality. If you ask people of all incomes if a more progressive tax system would make low-income households happy, everybody said yes. And indeed, poor households experience significantly higher levels of happiness in a more progressive tax system.
However, if you asked people of all incomes if a more progressive tax system would make high-income households less happy, everybody said yes. Yet, if you actually measured the happiness of the 20% of households with the highest income, it did decline marginally, but the decline was not statistically significant. In fact, if you waited five years, the rich were just as happy in a progressive tax system as they were in a less progressive system, while the poor were materially happier.
Correlation between progressive taxation and happiness
Source: Oishi et al. (2018)
What seems to be at play here is what Robert Frank calls “the mother of all cognitive illusions”. When we think of ourselves as having to pay more taxes, we think of our income today and then imagine we have to pay more taxes to end up with lower income tomorrow. That is the correct perception if we think about losing money with investments or because we are being robbed. But if we are being “robbed” by the government in the form of taxes, it’s not just us who have less. Everyone who has a similar income to us will lose a similar amount. We all get poorer at the same time and by roughly the same amount.
Hence, when we think about higher taxes, we ignore the fact that relative to our peers we are not getting worse off. And what matters for our happiness is not our absolute level of wealth or income, but our status relative to others. Think about it in the way Frank describes: If high-income households all have to pay more taxes, they won’t be able to afford a Ferrari anymore and may have to downgrade to a Porsche. But because everybody has to downgrade to a Porsche, you are still driving the best car on the road. The difference is just that in a world of low taxes you can buy a Ferrari but due to a lack of infrastructure investments by the government, you couldn’t drive it because the roads are in disrepair. In a world of higher taxes, on the other hand, you have a Porsche and can drive it on a smooth road.
What would you prefer? And before you complain that this is a contrived example, let me tell you that when I was working on a project in Saudi Arabia, one of the executives of the company I worked for told me that he once bought himself a Ferrari. He decided to give it back after a few months because he said he couldn’t drive it because the roads in Saudi Arabia were so bad. So now he has a Mercedes SUV.
This is an interesting note, but I think you are drawing the wrong conclusions here.
First, we should be highly sceptical of advocating for a policy simply because it makes people happy. That is not a sufficient condition to implement the policy. It may be sufficient for you, and I suspect a large portion of the population, but I believe more questions need to be answered before anyone, be rich or poor, advocate for it.
For example, the UK polling company YouGov produces various polls that show the British public are highly dubious of some liberal policies, e.g., support for capital punishment. Should we support capital punishment because it is popular empirically? Maybe, maybe not. But we should be consistent. If you argue that we should support progressive taxation because it makes people happy, we should use the same logic for other policies: capital punishment, straight immigration rules, etc.
https://yougov.co.uk/topics/politics/articles-reports/2014/08/13/capital-punishment-50-years-favoured
Second, why do we think doing more of a policy that is already failing (in some aspects) would work better? The UK already has a fairly progressive tax system, and it has led to huge inequality and many other undesired effects, such as gentrification. Generally speaking, if policy X results in Y, where Y is not desirable, why would one (logically) advocate for even more of X? It doesn’t make sense. I suspect because Y is not easily observable.
A parody of this is the following: liberalism has some problems which are cured by more… liberalism! That does not make sense.
Third, what are the knock-on effects? A more progressive tax system may have unintended consequences that are not desirable. This can be categorised as a “Bootlegger and Baptist problem”.
https://en.wikipedia.org/wiki/Bootleggers_and_Baptists
It is easy to see who the Baptists are in this example – left-wingers who want higher taxes on the rich. What is not so easier to see is who the Bootleggers are. Maybe they don’t exist – but how sure are we of that?
Fourth, we should be very careful about what it means to be happy on a relative basis. You can make an argument like this: pick a communist state, such as the Soviet Union, and you will surely find that the poor were very happy on a relative basis, because the inequality between the rich and the poor drastically reduced as Stalin took power. Is this desirable? If one’s view on happiness is that it is relative (as you suggest), not absolute, then the answer is surely yes.
Of course, the example in this argument is extreme, but you can see the problem: in an attempt to reduce inequality, you may destroy your society, and competitor states, e.g., low-tax states, will happily take the rich people in. This is happening, to some extent, in the US: many people from California and NYC are leaving to go to states such as Florida.
Fifth, are we sure that the government would spend the tax money in an efficient manner? This one is easy to answer, in my opinion, because it is quite obvious that government spending is inefficient in some regards. One could argue that starving the beast would result in higher efficiency, e.g., austerity policies, but these are not popular. Speaking as a UK resident, I would say that the progressive taxation system here is not a disaster, per se, but it is nothing to be proud of. It is quite inefficient, I would say.
I think this notable quote by Hayek captures my above arguments in a nutshell:
“The curious task of economics is to demonstrate to men how little they really know about what they imagine they can design. To the naive mind that can conceive of order only as the product of deliberate arrangement, it may seem absurd that in complex conditions order, and adaptation to the unknown, can be achieved more effectively by decentralizing decisions and that a division of authority will actually extend the possibility of overall order. Yet that decentralization actually leads to more information being taken into account.”
In short, we should be highly skeptical of increased progressive taxation.