Governments need to apply behavioural insights to the way they approach tax reform

A new report from the Institute for Government looks at ways in which governments can carry through the reforms that the UK tax system needs. In recent years chancellors have tinkered with taxes, but shied away from, or been frustrated in, attempts to tackle the underlying distortions and inefficiencies in the tax system which threaten the long-run revenue raising capacity of the state.

One theme in the report is the need to think about how behaviours shape the way we look at the tax system – and how people will react to reform. The Behavioural Insights Team and the IfG previously explored the behavioural biases that decision-makers in government need to be aware of in a 2018 report, Behavioural Government. So, what might “behavioural tax policy making” look like?

Availability biases and attention cascades shape the debates around tax

There is clear evidence that some issues cut through and others don’t. Immediate, attention-grabbing issues attract notice – and others do not. Ministers rush to tighten regulations in the wake of a rail crash that kills handfuls of people – but are under no similar pressure to act on the much higher annual toll of road deaths. Indeed, that very tightening may lead to more deaths overall.  

The tax system as a whole does not cut through, and its structural weaknesses receive relatively little attention. Our report shows that there is a very low level of public understanding of the way the system operates, with most taxes quite well hidden from the population – such as VAT, or income tax and National Insurance contributions which are taken from pay packets for all employees through PAYE. The most noticeable taxes are those which require an explicit payment – one reason why ministers have repeatedly ducked a long overdue council tax revaluation (for England at least) – or where they trigger a visible price change, which is one reason why fuel duties have been frozen in cash terms for over a decade.

That means there is little pressure for, or understanding of, the need for long-term reform: it is not “available”. But if a chancellor floats the idea of change, he triggers an “attention cascade” – with the focus entirely on the proposed measure. As lobbyists mobilise and headlines denounce the change, the wider reform context can be lost – and ministers invariably back down.

Ministers and parliament need to use those biases to pave the way for tax reform

The traditional approach to the budget in the UK – of a chancellor preparing a budget behind closed doors in No.11 Downing Street and then pulling proverbial rabbits out of a hat – does nothing to offset these biases.

Our report recommends much wider public debate on tax issues and the tax system as a whole – to “roll the pitch” for reform and negate these biases. That can take many forms: more openness from the Treasury, such as publishing officials’ papers on tax reform as happens in Ireland or New Zealand; the use of a tax commission to take evidence and involve the public, as happened in the case of the reform of pensions which laid the ground for raising the state pension age (previously thought unthinkable) and automatic enrolment; and greater parliamentary engagement on the tax system. These could even create positive attention cascades to promote reform.

Opening up discussions on tax will also help deal with the so-called illusion of similarity – the belief that other people will think like decision-makers. In his memoirs, David Cameron describes the discussions that led to the omnishambles budget in 2012, in which George Osborne attempted – but quickly had to reverse plans – to impose VAT on pasties and static caravans: “far from thinking we were running into a hail of bullets, we believed we had dodged the worst of them. A big mistake”. That was because ministers had been through a range of options – including VAT on take-away sandwiches – and thought they had been left with the most sensible options. But the public had not been part of that discussion – and pasties suddenly became the focus of an attention avalanche which swept away part of Osborne’s budget.

Loss aversion is an important part of the tax reform puzzle

One of the most established findings in behavioural economics is the power of loss aversion – that people feel a loss much more keenly than a gain of equal size. This is important when thinking about tax reform.

First, ministers should be wary of introducing any new tax break that might one day need removing – since they will incur greater opprobrium when they try to remove it than any praise for its introduction. Second, the weight of public opinion is likely to be negative in response to even revenue neutral tax changes, even if (and this is rarely the case) the gains are equally as concentrated as the losses. Persuading the public to accept tax reform will be even more difficult if – as is likely to be the case – the losses from reform are more concentrated than the gains and if there is insufficient revenue to compensate the losers. 

Ministers in search of reform need to think through how they will deal with the loser problem: by constructing a package to cushion the change, or by phasing it in gradually. They will be helped if reform is part of a clear long-term strategy. They also need to beware creating potential future losers: it is easy to create reliefs – much harder to take them away.

Coronavirus has reshaped the debate

In the face of the threat from coronavirus, the need for so many to rely on the state for their lives and livelihoods has made tax reform both more urgent but also more possible. Chancellor Rishi Sunak has rightly started to climb through that window of opportunity. But he needs to keep building that case to help conquer the biases that may otherwise thwart him. Our new report has suggestions for how he might do that.