How to Hate Taxes a Little Bit Less (Ep. 400 Replay)

SPEAKER_10: Free economics radio is sponsored by emergency new immune supporting emergency crystals bring you the goodness of emergency in a fun new popping experience. There's no water needed just throw it back in your mouth. Feel the pop hear the fizz and taste the delicious natural fruit flavors like orange vitality and strawberry burst. Look for emergency crystals wherever you shop. These statements have not been evaluated by the Food and Drug Administration. This product is not intended to diagnose, treat, cure or prevent any disease. Free economics radio is sponsored by Capital One Bank. With no fees or minimums banking with Capital One is the easiest decision in the history of decisions. Even easier than deciding to listen to another episode of your favorite podcast. And with no overdraft fees is it even a decision? That's banking reimagined. What's in your wallet? Terms apply see Capital One dot com slash bank Capital One N.A. member FDIC. Hey there it's Stephen Dubner. In the U.S. where Free economics radio is based we are approaching a special day. Millions of people in the U.S. are getting ready to file income tax returns but the thought of doing it can be daunting. If only there were a way to make tax paying a bit more enjoyable perhaps even meaningful. That's the theme of the episode you are about to hear. It's an update of a show we first published a few years ago. It's called How to Hate Taxes a Little Bit Less. Hope you enjoy. SPEAKER_02: I never thought people would give money to government voluntarily. I ran this experiment to show that. SPEAKER_10: Catherine Eckel is an economist at Texas A&M University. SPEAKER_02: But then it turned out that people will give money to government voluntarily if they support what the government is doing. SPEAKER_10: Just to be clear, Eckel is talking about people giving money to the government above and beyond what they owe in taxes. This experiment she ran has some history. SPEAKER_02: So in the 1990s my collaborator Phil Grossman and I we were looking at the experimental research on what are called dictator games. SPEAKER_10: Dictator games had grown out of another lab game called Ultimatum which in turn grew out of a famous game theory experiment called the prisoner's dilemma. Anyway in the dictator game. SPEAKER_02: In the dictator game you have an amount of money and you have an option to give some of it say to me. The gift is anonymous. Nobody's watching you. You can do whatever you want. And economic theory would predict that you would just keep it. But in fact people give money away. They don't give a lot away but they give some away. SPEAKER_10: You can see why economists would love an experiment like this. It seemed to quantify the sort of preferences that were hard to measure in the real world especially before the current digital era. Today you can measure preferences just by seeing what people click on or don't. As Eckel told us the dictator game seemed to show that people are generally altruistic at least a little bit. So she decided to push harder on the altruism idea. SPEAKER_02: Altruism goes up when there's more of a reason to give the money away. We substituted a charitable organization for the anonymous person down the hall. In our first paper it was the American Red Cross. And we found just a huge increase in giving to the American Red Cross as compared with an anonymous person down the hall. SPEAKER_10: That makes sense doesn't it? The anonymous person you don't know if they even need your money but the Red Cross they specialize in disaster relief. So they'll probably use the money to help people who really need it. Now we should say that a lot of early dictator game research has been challenged. The economist John List has argued that rather than measuring altruism it was more likely measuring how the participants in these experiments who are often college undergrads were responding to the scrutiny of the professor who's running the experiment. We wrote about this in our book Super Freakonomics in a chapter called Unbelievable Stories About Apathy and Altruism. So Catherine Eccl… SPEAKER_02: So my co-author and I were interested in trying to figure out if what people were doing was really altruism. So in our experiment people came in and they either earned or were given an amount of money we call it their endowment. And then they had the option to give some of it to this charitable organization. They have a real amount of money and they're giving to a real charity. So it's an actual decision that they're making. They're forgoing some of their own income in order to give some money to somebody else. SPEAKER_10: When Eccl saw her research subjects giving money to a charity a new and interesting question came to her. What about the government? Would people donate to the government for the same reasons as they gave to charity? Maybe, but maybe not. When you give to a charity you have a pretty clear idea what they're going to do with the money or at least what you hope they'll do with it. And presumably you only give money to charities with a mission you like. When you pay your taxes it's a different story. For starters it's not easy to know exactly how your tax dollars will be spent. But also the government may spend your money on things you don't like. So Catherine Eccl, in designing a new experiment, addressed that problem. She asked her research subjects if they wanted to donate some money to the government but for a specific purpose, which happened to be the same purpose as the Red Cross donations, disaster relief. SPEAKER_02: And what we found to our shock and astonishment was that people would give almost as much to a government organization as they would to a private organization. Allowing people to earmark is really successful at getting people to give more. SPEAKER_10: This gave Eccl another idea. Maybe these findings could help address one of the biggest economic problems in the United States. The tax gap. That's the difference between the tax that is owed the federal government and what's actually paid. The US tax gap is considered quite large for a rich country. The IRS says it's around 15 to 20 percent of the total amount due. This adds up to $496 billion, nearly half a trillion dollars each year in unpaid taxes. But here's the amazing thing. That is just a little bit more than the amount that Americans donate each year to charities. We happen to be an extraordinarily charitable nation. Again, this may not be a measure of pure altruism. We may give to charities because of social pressure or for the ego boost you get if other people see your name attached to the donation. We may give because of what's called the warm glow that goes along with donating. And let's be honest, we may give because of the tax break. Still, this urge to give got Katherine Eccl thinking that maybe, just maybe, if there SPEAKER_02: was a little bit of scope for people to direct their money, that would increase tax compliance. SPEAKER_10: There's a lot of conversation these days about whether to levy more taxes, especially on corporations and the wealthiest individuals. Today, on Freakonomics Radio, wouldn't it be a good start to collect the taxes that are already due but aren't being paid? And what if you could choose, even just a little bit, how your taxes will be used? SPEAKER_04: Let's stir some competition by actually creating a market mechanism where the citizens can choose. SPEAKER_10: And what if you could also choose a small gift in return for your tax donation? SPEAKER_04: So for all intents and purposes, it's no different from shopping on Amazon. Would this actually work? SPEAKER_06: I'm skeptical about how far you can get with the carrot approach. Are you skeptical? SPEAKER_10: You'll have a chance to figure it out right after this. SPEAKER_01: This is Freakonomics Radio, the podcast that explores the hidden side of everything with your host, Stephen Dubner. SPEAKER_10: In case you hadn't realized, tax policy is a big deal. SPEAKER_06: The impact of the tax system is absolutely pervasive. That's Joel Slemrod. I'm a professor of economics at the University of Michigan. SPEAKER_10: Slemrod has been at it for a while, and he knows quite a bit about taxes. SPEAKER_06: Yes, 95% of my papers have the word tax in some form or another. SPEAKER_10: And why such a devout interest in tax policy? It touches on just about everything. SPEAKER_06: It affects decisions that people don't think of as economic. Whether to get married, how many kids to have, all of those decisions have tax aspects. They affect the rewards to certain activities and the costs of many activities. SPEAKER_10: Activities including death. Imagine you're old and frail, you don't have much time left. And imagine the estate tax is about to be lowered. Here's what Slemrod and his co-author, Vojcic Kopchuk, found in a study they called, Dying to Save Taxes. For individuals dying within two weeks of a tax reform, they write, a $10,000 potential tax saving increases the probability of dying in the lower tax regime by 1.6%. In other words, the dying person hangs on just long enough to die under the new estate tax rate. Or if you are a suspicious type, you might imagine the dying person's family tries to prolong their life in order to pay less tax, or maybe even fake some paperwork after the fact. In any case, that's how much effort can go into avoiding taxes. Although some people don't go to that much trouble, they just decide to not pay what they owe or to not declare all their income. SPEAKER_06: The best estimate we have is that for federal taxes, about 16% of what should be remitted is not. SPEAKER_10: Now, that 16%, again, this is the tax gap we're talking about, that needs to be pulled apart because there are two distinct categories of taxpayer, those who have good opportunities to cheat and those who don't. If you are an employee, you likely belong to the second category, not much chance to cheat. SPEAKER_06: The IRS guesses that if you're an employee and you have wages and salaries, the non-compliance rate is about 1%. SPEAKER_10: And that's because your taxes are being automatically withheld from your paycheck. So if you really want to cheat on your tax return, you'd have to do something like fake a bunch of charitable contributions or claim deductions for your 37 children, which is probably more children than you actually have. The point is the IRS already knows, thanks to the W-2 form your employer generates, exactly how much money you've made and how much you've already paid in taxes. On the other hand, if your income is self-employment income where there is no third party reporting, SPEAKER_06: they think that number goes from 1% to over 60%. SPEAKER_10: To over 60% non-compliance, how is that even possible? Well, note exactly what Joel Slemrod said. SPEAKER_06: If your income is self-employment income where there is no third party reporting. SPEAKER_10: That is, if you work for yourself and someone pays you directly, they don't necessarily generate a tax document the way an employer does. Say you run a restaurant or a construction company or a farm. The IRS doesn't know how much money you actually made because nobody told them. It's up to you to give the IRS a figure. And they don't have the right to request your bank records unless you're already being audited on suspicion of tax cheating. So without third party reporting, people with self-employment income have a real temptation to lower the income they report. Then there's income from business partnerships and investments, all of which tends to be fairly opaque and also tends to accrue to wealthier people who have greater resources for what you might call tax management. All this underreported income is responsible for about 80% of that nearly half trillion dollar tax gap. The rest is due to underpayment or outright non-filing. But these are all forms of tax evasion, which to be clear is not the same as tax avoidance. What's the difference? Well, technically the difference is that avoidance are legal ways to reduce your taxes and evasion SPEAKER_06: are illegal. I think the nicest description of that comes from Dennis Healy, who was chancellor of the Exchequer in the UK. And he said the difference between avoidance and evasion is the thickness of a prison wall. SPEAKER_10: And lest you think tax evasion is a new problem, think again. We will get into the history of tax evaders and much more after the break. I'm Stephen Dubner. This is Freakonomics Radio. We'll be right back. Freakonomics Radio is sponsored by Canva. If you need to design visuals for a brand, the online design platform Canva makes it easy. With Canva, you can keep your brand's fonts, colors, logos, and graphics right where you design presentations, websites, videos, and more. Create brand templates to give anyone on your team a design head start. Drag and drop your logo into a website design or click to get your social post colors on brand. With just a few clicks, you can save time resizing social posts too with Canva Magic Resize. If you're a designer, Canva saves you time on repetitive design tasks. No design resource, just design it yourself. With Canva, you don't need to be a designer to design visuals that stand out and stay on brand. Start designing today at Canva.com, the home for every brand. It's an uncertain time in fixed income right now. Get commentators obsessed over whether the economy will have a hard, soft, or extended landing. No matter what happens, Vanguard is focused on the journey. Vanguard's active bond funds are supported by an expert active team able to take advantage of today's higher yields. Vanguard active fixed income practices smart risk-taking discipline strengthened by Vanguard's low fees, which give its active portfolio managers the ability to help seize the right opportunities to outperform at the right time. That's the value of ownership. Learn more at vanguard.com slash vanguard active. Visit vanguard.com to obtain a fund prospectus or summary prospectus containing investment objectives, risks, charges, expenses, and other information. Read and consider carefully before investing. All investing is subject to risk. Investments in bonds are subject to interest rate, credit, and inflation risk. Fund shareholders own the funds that own Vanguard. Vanguard Marketing Corporation distributor. SPEAKER_06: If you look back and recorded history, some of the earliest things we know about societies have to do with tax payments and tax evasion. SPEAKER_10: That again is the University of Michigan economist and tax expert Joel Slemrod. For millennia, taxation has been perhaps the most powerful tool, some might say weapon, that a government or crown can wield. Countless rebellions and revolutions were driven by tax issues, our own revolution included, at least to some degree. In 1774, Alexander Hamilton warned his fellow colonists that if Britain's appetite for taxation were left unchecked, all the Americans tables and chairs and knives and forks and everything else would be taxed along with every child and every kiss your daughter received from their sweethearts. The earliest records of tax avoidance go back to the 7th century BCE in Egypt, where aging patriarchs would transfer property to family members to avoid inheritance taxes. Avoidance and evasion have continued pretty much unabated ever since. In 17th century England, for instance, they wanted to have a tax on real estate that was SPEAKER_06: higher the more grand your residence, but it wasn't easy to get a sense of the value of a residence. So, what could you easily observe that would be an indicator of how fabulous your residence was? Well, first they tried fireplaces. The problem is that you have to have somebody go inside. What is correlated with the grandness of your home for which you don't have to go inside? Windows. So, for centuries there was a tax based on how many windows a house in England had. SPEAKER_10: How did the glaciers and glassmakers respond to the window tax? SPEAKER_06: There was some extra business because, as always, when there is a tax, the creative juices of avoidance and evasion get rolling. So, what you can still observe to this day in England is how older houses where it's clear there was once a window and then it was bricked up to reduce window tax. We also know there were cases where windows would be installed that would allow light to come into two different rooms. So, the glaciers had some business there. SPEAKER_10: I'm curious about where an action like that would fall on the line between avoidance and evasion. SPEAKER_06: Yeah, I would call that avoidance except if I got word that the tax inspector was coming by and I bricked up my window the week before and then after the inspector passed, I unbricked it. That one maybe sounds like evasion. SPEAKER_10: Another odd tax that's been levied throughout history is the bachelor tax. Since, as everybody knows, unmarried men cause nothing but trouble, which must be paid for, this tax also led to some novel workarounds. SPEAKER_06: In at least one country that had a bachelor tax, there was an exception that if you could prove that you had asked a woman to marry you and she had refused, then you were exempt from the tax. So, a market arose for what were called professional lady rejectors who for a fee would fill out the forms saying, yes, you had asked them for their hand in marriage and they had refused and you would take this to the tax office and be exempt from the bachelor tax. SPEAKER_10: There has been a lot of talk lately of instituting new wealth taxes in the US. President Biden has called for Congress to pass a billionaire minimum tax, a 25% tax on households worth more than $100 million. Knowing what we now know about professional lady rejectors and bricked up windows, you can imagine that the targets of a new wealth tax would likely prove quite adept at avoidance, if not outright evasion. That has been the case in several European countries where wealth taxes have been tried. As one recent OECD report put it, the revenues collected from net wealth taxes have with a few exceptions been very low. In France, for instance, more than 40,000 millionaires left the country between 2000 and 2014. For what it's worth, American economists who support these wealth taxes insist that they've learned from the Europeans' experience and that the US has some advantages. Unlike many European countries, for instance, the US already requires its citizens to report income to the IRS regardless of what country they live in. But given the seemingly eternal and universal urge to avoid paying taxes, one imagines that other creative solutions would be found. So what's a country to do if it wants to increase tax compliance? Here's one clue. The IRS reports that 96% of respondents to an independent poll agreed with this statement. It is every American's civic duty to pay their fair share of taxes. But when asked why they pay, 62% answered fear of an audit. SPEAKER_06: One thing we've learned is that any kind of correspondence tends to increase tax compliance, maybe because taxpayers just get a correspondence and say, oh my gosh, the IRS knows I exist, and they didn't realize that before. SPEAKER_10: So you're a more stick guy than carrot. I'm more of an incentive guy, so either carrots or sticks are incentives. SPEAKER_06: But among incentives, I think the evidence suggests that sticks work better than carrots. SPEAKER_10: But Slimrod says the IRS doesn't have a very big stick. SPEAKER_06: The real budget of the IRS is down over 20% since 2010. Audits are down a third. SPEAKER_10: The Inflation Reduction Act, which passed last summer, gave the IRS nearly $80 billion over the next 10 years to supplement its budget. That funding might pay for itself since an audit can return as much as $4,500 per hour of IRS labor. SPEAKER_02: And if you are caught, generally what happens is that then you have to pay them and a little SPEAKER_10: bit more. That again is Katherine Eckel. SPEAKER_02: So there's not a huge penalty associated with failing to pay your taxes. I mean, on one hand, the gospel is that everybody hates taxes. SPEAKER_10: And that is Kate Lamberton of the University of Pennsylvania's Wharton School of Business. SPEAKER_08: But on the other hand, I saw this data from the World Values Survey that said, you know, we really feel like we should pay them. You know, it's a really small percentage of people who say it's okay to cheat on your taxes. So as much as we hate them, we tend to comply. SPEAKER_10: Lamberton is a marketing professor. SPEAKER_08: Which means I study consumer behavior, which is basically the psychology behind the way that people make decisions with money. SPEAKER_10: While it is true that many people pay taxes because they're afraid of getting caught if they don't, Lamberton points to another more encouraging reason for compliance. Well, there's been quite a bit of research done on social pressure, right? SPEAKER_08: So if you feel like everybody else is paying, then you feel like you probably should as well. Trust in government certainly has an influence. If you don't trust your government, then what's the point of giving them your money? People can also seek to avoid negative emotions, like they don't want to feel shame. But wouldn't it be nice if people could feel not just not bad about paying taxes, but actually SPEAKER_10: feel good? That's essentially what Katherine Eckel was going for in a follow up to the experiment she did about disaster relief. In that one, you will recall, people would give almost as much to a government organization SPEAKER_02: as they would to a private organization. SPEAKER_10: But how much of this effect was because people could specify where their money was going, something we can't do when paying taxes. SPEAKER_02: And so we looked around and we found this amazing fund called the Gifts to the United States Fund. We didn't even know it existed before, but it does. It's a real thing. You can write them a check. And then we designed a new experiment that compared people's giving to that fund. SPEAKER_10: In this experiment, she compared what people were willing to give to the fund without knowing how the money would be spent. SPEAKER_02: That's like really voluntary taxation because you have no control over how it's going to be used. SPEAKER_10: Versus the amount people would give if they could earmark their money for a specific purpose. Other research, for instance, or affordable housing. SPEAKER_02: So when people know that their money is going to be used for a cause that they support, they're much more willing to part with it than otherwise. SPEAKER_10: How much more? Eccles study found that they were twice as likely to give to a specific cause than to the general fund, and they donated roughly two and a half times more. So it would seem that being allowed to allocate your tax dollars might significantly increase compliance. That's an idea Kate Lamberton has also been studying. SPEAKER_08: So none of us likes to be forced to do things, right? I don't have a choice about paying my taxes. And that in itself, even if I feel a civic duty, makes it kind of an unpleasant task. Even people who would feel predisposed feel a certain sense of what's called reactance. So they push back against it. SPEAKER_10: There's another factor that can make paying taxes unpleasant. SPEAKER_08: The other factor is the decoupling. SPEAKER_10: Meaning the paying in your tax money isn't coupled with any sort of tangible benefit the way it is when you buy something for yourself. SPEAKER_08: The benefits are very diffuse. It's kind of like you're seeing something from a more distant vantage point. The benefit looks smaller, the cost looks bigger. SPEAKER_10: One way to change taxpayers' minds, or at least inform them about how their money is being spent, is to make the data accessible. SPEAKER_08: The Obama administration had a website where you could go and put in the amount of tax you paid and see what it was spent on. And those interventions have pretty mixed results, because one would argue all they do is address recoupling. All they do is reconnect the payment to the benefit. They don't introduce any ideas about agency. So what we wanted to do was to try to address both of these things with one intervention. SPEAKER_10: Here's the intervention that Lamberton and her colleagues came up with. SPEAKER_08: So we said, what if we don't just give you the pie chart? We let you say how you would like the money to be allocated across that pie chart. And in one study, in a lab study, we could show that tax compliance changes when people have the opportunity to express their opinions about the way their taxes are spent. Again, I want to point out that the subjects of a lab experiment like this aren't necessarily SPEAKER_10: responding the way people in the real world will respond. Nevertheless, the results from Lamberton's study suggest that getting to allocate your own tax dollars, at least to some degree, could increase compliance by up to 15%. SPEAKER_08: If you let people have a voice in the way their tax dollars are spent, they're much more satisfied with paying them. Okay, great. SPEAKER_10: But there is a fly in this ointment. The kind of spending the average taxpayer might like isn't necessarily the spending a government might need to make. SPEAKER_08: It's hard because some categories are inherently more appealing. Perhaps they're more personally relevant to people. SPEAKER_10: For instance, education and medical research and military spending, all of these have obvious concrete constituencies. Whereas paying down the interest on the national debt or funding long-term infrastructure, not so sexy. SPEAKER_08: There are things that are completely non-transparent to most of us. I think that that's a reason why a 10% allocation makes sense. SPEAKER_10: Meaning a taxpayer could specifically allocate just 10% of their total tax bill. SPEAKER_08: There is work going on all the time that taxes pay for that, you know, we notice when it's not done. We don't notice when it's done. And those things do need to be protected and they do require investment. SPEAKER_10: To Lamberton, the idea of allocating a portion of your personal tax bill is worth bringing out of the lab and into the real world. In the U.S., a process called participatory budgeting has been tried by some local governments and often there's a vigorous debate about the way money should be spent. SPEAKER_08: And there is a little bit of a danger there because then you end up with the people in the room who care the most and those people likely have pretty strong opinions about what's going on. SPEAKER_10: Lamberton likes to think this could work better on the federal level and without the need for public debates. For starters, there's already a mechanism on the federal tax form. SPEAKER_08: So we have a little box on our tax form that we can check to direct money to the presidential campaign fund. That is a very simple introduction of agency that's just a yes, no. It does seem to me possible that we could expand that expression of agency. SPEAKER_10: But is there a concern that participatory budgeting would radically realign the actual federal budget? Based on the evidence from her research, Lamberton doesn't see that happening. SPEAKER_08: So in the aggregate, what ends up happening in the U.S. at least is the defense budget, which is a huge, huge portion of the pie goes down. And I will say that's in part because our participants tended to be slightly more liberal than the population as a whole. But a lot of the other budgetary categories don't change an enormous amount. So while on an individual level you might see big change in the aggregate, it actually isn't a seismic shock that would be that different from what you would see when an administration changes. SPEAKER_10: OK, if you believe that giving people some power over their tax payments will increase tax payments, what's the next logical step? SPEAKER_04: The hometown tax system is absolutely fantastic. SPEAKER_10: Coming up after the break, we travel to Japan with the thought of stealing one of their very interesting tax ideas. We'll be right back. You're listening to Freakonomics Radio. Hey, everyone, there is a new show for you. It's the story of a woman who discovers her uncle's secret life buried inside a low-budget 90s thriller that starred Rob Lowe and Ice-T. The podcast is called Magnificent Jerk. It's a journey through Chinatown gangs, drug robberies, Hollywood reinvention and a family confronting its unspoken past. Magnificent Jerk, the true story of a fake story about a real life. Magnificent Jerk is an Apple original podcast produced by Pineapple Street Studios, available on Apple podcasts. SPEAKER_03: Hear that? Pumpkin. That's phone calling. And the pumpkin spice latte is back at Starbucks from that first sweater to late autumn weather. It's all a fall in just one sip. Order ahead on the Starbucks app. SPEAKER_09: Hello. That is Jesper Kohl. SPEAKER_10: He's an economist by training originally from Dusseldorf, Germany. SPEAKER_04: I have been stuck in Tokyo for the last 35 years. SPEAKER_10: These days he works for the Monex Group, a financial services firm. Before that, I first worked for three years in Japanese politics and then moved on into SPEAKER_04: the world of finance, being the chief economist and head of research for both Merrill Lynch and JP Morgan. SPEAKER_10: So Kohl is fairly steeped in Japanese politics and economics, which we should say he adores. I mean, I've said this time and again, I want to be reborn as a 23 year old Japanese. SPEAKER_10: Kohl has been called the last optimist about Japan, whose economy has for decades been marked by stagnation and even deflation. Japan's citizenry is aging. Despite labor shortages, the country's traditionally been reluctant to allow foreign workers, although that's finally changing. But Jesper Kohl isn't worried about any of it. SPEAKER_04: The Japanese economy is the envy of the world in the sense that it actually balances multiple outcomes, whether it is economic freedom, whether it is equity, whether it is growth. You find that overall the outcome that the economy produces for the citizens of Japan is absolutely fantastic. SPEAKER_10: That said, even an optimist of Kohl's intensity admits there are structural issues. SPEAKER_04: The Japanese economy ultimately is very much a two tiered economy in the sense that you've got the economic concentration in the mega cities, Tokyo, Osaka and Nagoya. Those three centers effectively account for about three quarters of Japan's employment and value at creation. So the hinterland, the rest of the country, effectively is always in deficit. And that, if you look at the Japanese national budget, is also reflected in a very big redistribution effort. If the budget in Japan is about 80 trillion, you find that almost 20 trillion go to redistributing funds from the rich urban centers into the regions of the economy. SPEAKER_10: By the way, those trillions Kohl is talking about are yen, not dollars. In any case, what's happening in Japan, the imbalance between cities and the hinterland, is not so different from what's happening in many countries, including the US, as the world gets more urbanized. But in Japan, it's extreme. 92% of the Japanese population lives in urban areas. In the US, that number is just over 80%. The trend in Japan, as elsewhere, is that young people who grow up in rural areas eventually move to the big city, which leaves their hometown with an aging population and a depleted tax base. To fight this problem, Japan introduced in 2008 what's called a hometown tax system, or furusato noze. It allowed people to make donations to their hometowns, which after the first 2000 yen, or roughly $15, can then be deducted from their personal taxes. But here's the thing, the donation, despite the name, didn't actually have to be to your own hometown. You could direct the money to any region. Nor did you even have to be from a rural area to take advantage of the hometown tax. And here's maybe the most Japanese thing about the hometown tax. When you made a donation to a particular region, they would send you something nice in return. It was brilliant in the conception, in the sense that there was a strong realization SPEAKER_04: that yes, the bureaucrats at the central governments are doing a perfectly fine job of redistributing from the urban centers into the regions, but let's stir some competition by actually creating a market mechanism where the citizens can choose which regional products they want to buy and create an incentive by making those products tax deductible from their national tax, thereby creating competition amongst the different villages, amongst the different regions, and creating entrepreneurial spirit in the sense that entrepreneurs are now actively marketing their products. SPEAKER_10: My understanding was that when you were filing your taxes, you could direct a portion of your local payment to anywhere else. And in exchange for that, quote, donation or direction, that those local towns or prefectures would then send me some kind of gift, some kind of thank you. SPEAKER_04: It was never a gift. It was never a gift. It was very conscious policy, you know, this whole catalogs of the goods that I want to buy. So it's not as though I get a random gift. I know perfectly well that the only thing from Nagano I'm interested in is this local brewer who has this excellent micro beer. It's no different from shopping on Amazon. You know, you've got by different prefecture, by different villages, you've got the list of the approved products, and this is effectively what I buy with my donation. SPEAKER_10: Most of the products are food or beverages, local delicacies, specialty seafood, micro brews. Elsewhere, a handmade sword by a master swordsmith available for a tax donation of around 45,000 US dollars. One town known for its seafood attracted 116 million dollars in directed donations, the most of any municipal government. In 2021, hometown tax donations in Japan totaled more than 6 billion US dollars. Jesper Kohl notes that one criticism of the program is that it disproportionately benefits higher income households, since the maximum tax donation is in part a function of your income. But it's also worth noting that charitable giving in Japan is not nearly as prominent as it is in the United States. SPEAKER_04: No, you make a very, very important point. Tax deductible donations for charity are very, very difficult to do. To set up a foundation, to set up a nonprofit that actually is eligible for tax deduction sometimes takes five to six years, even if you've got support from the highest levels. So effectively, the hometown tax system is the most direct and most frequently used part of tax deductibility that is actually available. Is it made so difficult as a means of fraud prevention or is there another reason? SPEAKER_04: Correct. It is made very difficult for fraud prevention. You know, contrary to the American perception, Japanese are extremely entrepreneurial. And if you've lived in deflation for one generation, trust me, you know how to eke out an additional one yen or one nickel. SPEAKER_10: So the hometown tax scratches a variety of itches. It redistributes income from the big urban areas. It gives people, at least high-earning people, a way to contribute to specific causes since many towns advertise what the funds will be used for. And it rewards donors with nice stuff. It also, as Jesper Kohl likes to argue, drives the entrepreneurial spirit. SPEAKER_04: It has actually created competitions with the different regions, whether it's Nagano, whether it's Hokkaido, whether it's Okinawa, now competing to offer their products to the customers. This is not about building bridges to nowhere, which is what sometimes the Japanese central government construction ministry likes to do. But it's actually creating genuine private sector entrepreneurship. If you're in a local village and you're a micro brewer, trust me, the scheme is incredibly important. SPEAKER_10: You could also imagine the hometown tax nudging people toward higher tax compliance. At least that's the hope. For one thing, you have to actually file a tax return in order to get the deduction. In any case, not everyone is as bullish on the hometown tax idea as Jesper Kohl. Other economists offer a number of criticisms. A lot of time and money is devoted to marketing a region's products to the big city taxpayer. A 2020 research paper found that competition between municipalities to offer increasingly valuable gifts reduces net revenue by about 7.5%. The system can also result in a wildly uneven redistribution of funds. For instance, the town famous for its seafood that took in $116 million, it only has about 20,000 people. And of course, all that tax money flowing to the hinterlands means that Japan's big cities, which continue to grow, are losing revenue. I asked Jesper Kohl if there had been other unintended consequences. SPEAKER_04: It's very interesting. So unintended consequences are that the local governments have begun to cheat, which is to say that, you know, the local government will throw in an extra gift. In one case, the mayor offered for you to sit in the seat of the mayor's office for one day. There was one famous case where one of the villagers would throw in for free a handmade piano. So the local politicians said, this is great. We can actually boost our local revenue base by attracting more money from the people living in Tokyo or in Osaka. And as a result of that, they started to abuse the system. SPEAKER_10: In response, the government has tweaked the regulations about the types and value of gifts that can be marketed. Some prefectures used to offer Amazon gift cards, but they've been banned since they don't spur local production. Also, a cap was placed on the value of a gift. It can be no more than 30 percent of the tax donation itself. I asked Jesper Kohl, who went to college in the U.S., if he would suggest some version of the hometown tax here. SPEAKER_04: Absolutely. I think that the key point is, you know, how can I create a hybrid structure where, yes, I can use national policy to actually create incentives for local entrepreneurs to produce locally and to increase their sales, to increase the brand awareness of their products, you know, on the global stage. That's where the hometown tax system is absolutely fantastic. SPEAKER_10: Kate Lamberton, the Wharton marketing professor, sees the Japanese hometown tax idea as tricky territory. SPEAKER_08: People generally feel a strong responsibility to pay taxes. I think that one of the dangers there that Japan is facing in the long term is that they've taken that intrinsic motivation and they've translated it into something that's extrinsic now. SPEAKER_10: The second problem is called motivational crowding out. Consider the idea of paying students to get better grades. Some research shows a short-term improvement, but other research raises concerns that in the long term, you're killing off a kid's natural desire to learn and replacing the potential joy of discovery and mastery with anxiety over test results. The hometown tax data from Japan suggests there is some motivational crowding out. A municipality that rewarded donors with a gift was six and a half times more likely to get a donation than towns that didn't. SPEAKER_08: So say they do away with this program. What happens now is people say, well, I used to get cool stuff for paying my taxes. I don't get cool stuff anymore. So now that intrinsic motivation has been eroded and the extrinsic motivation has been taken away, it's possible that in the long term, what they end up seeing is a higher level of noncompliance than they did before this program existed. SPEAKER_02: Economists are really focused on incentives. SPEAKER_10: Katherine Eckel again from Texas A&M. SPEAKER_02: And they believe really strongly that if you give somebody an incentive to do something, that they're more likely to do it. But there's more and more evidence emerging that incentives can break a system that's already working without incentives. So a situation where people trust each other or people engage in reciprocity and help each other out, if you introduce incentives and then you take them back off again, you might have broken the system that's there before. SPEAKER_10: It's highly unlikely we'll ever see anything like Japan's hometown tax in the U.S. But what if, as both Eckel and Lamberton would like to see, the U.S. started offering taxpayers the opportunity to direct a portion of their money to particular departments or agencies? Would we start to see what the Japanese saw? Marketing campaigns and competition to solicit the most donations? And do we really want government agencies campaigning for our money? SPEAKER_08: To the extent that people don't notice what government does, it would not be a bad thing for agencies to say, look, here's what we do. Here's what your life would be like without us. An increased awareness of what government does in our lives could, to me, only be a positive. SPEAKER_10: Lamberton even thinks it might improve the average citizen's relationship with the government. SPEAKER_08: I've talked about some with this idea. They say, well, look, this would work the first time. People think something's going to happen, and then they see that it doesn't. And it would mostly create enormous frustration and, in fact, could have a backlash effect. And I would argue that even that conversation would be helpful. Creating a higher level of civic engagement, to me, that's not a negative. So you introduce agency. You also then introduce accountability and raise people's involvement with the tax-paying process and the federal or state allocation process. Could it raise frustration? Sure. However, I think it's a very valuable conversation. SPEAKER_10: Coming up next time on Freakonomics Radio. SPEAKER_00: There is a disconnect with what people say they believe, but what they're actually willing to do. SPEAKER_10: There is a lot of talk in the corporate world about ESG and DEI. One company decided to do something a bit different. SPEAKER_09: We decided to bet that bringing jobs to an area that hadn't had opportunity would be a good business decision. SPEAKER_10: Can a job change a life? That's next time on the show. Until then, take care of yourself. And if you can, someone else, too. Freakonomics Radio is produced by Stitcher and Renbud Radio. This episode was produced by Matt Hickey and mixed by Greg Rippon. We had help from James Foster and Ryan Kelly. Our staff also includes Zach Lipinski, Morgan Levy, Catherine Moncure, Alina Cullman, Rebecca Lee Douglas, Julie Canfer, Eleanor Osborne, Jasmine Klinger, Daria Klenert, Emma Terrell, Lyric Bowditch and Elsa Hernandez. The executive team of the Freakonomics Radio Network is Neil Carruth, Gabriel Roth and me Stephen Dubner. Our theme song is Mr. Fortune by the Hitchhikers. All the other music was composed by Luis Guerra. As always, thanks for listening. SPEAKER_06: Another one that I find fascinating is the beard tax. If you were going to go outside with a beard, you had to have a token that you purchased that showed that you had paid the beard tax. SPEAKER_01: The Freakonomics Radio Network. SPEAKER_03: Here. SPEAKER_07: Amika is a different type of insurance company. We provide you with something more than auto, home or life insurance. It's empathy because at Amika, your coverage always comes with compassion. It's one of the reasons why 98% of our customers stay with us every year. 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