400. How to Hate Taxes a Little Bit Less

Every year, Americans short the I. R. S. nearly half a trillion dollars. Most ideas to increase compliance are more stick than carrot — scary letters, audits, and penalties. But what if we gave taxpayers a chance to allocate how their money is spent, or even bribed them with a thank-you gift?

Speaker names marked ? are inferred from speaking time and the show’s known hosts — they are not voice-verified.

• 0:01Stephen J. Dubner?

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• 0:33Stephen J. Dubner?

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• 1:06Stephen J. Dubner?

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• 1:39Stephen J. Dubner?

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• 2:16Speaker 01

  I never thought people would give money to government voluntarily. I ran this experiment to show that.

• 2:25Stephen J. Dubner?

  Catherine Echol is an economist at Texas A&M University.

• 2:28Speaker 01

  But then it turned out that people will give money to government voluntarily if they support what the government is doing.

• 2:35Stephen J. Dubner?

  Just to be clear, Echol is talking about people giving money to the government above and beyond what they owe in taxes. This experiment she ran has some history.

• 2:43Speaker 01

  So in the 1990s, my collaborator Phil Grossman and I, we were looking at the experimental research on what are called dictator games.

• 2:52Stephen J. Dubner?

  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...

• 3:03Speaker 01

  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.

• 3:26Stephen J. Dubner?

  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 Echol 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.

• 3:52Speaker 01

  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.

• 4:10Stephen J. Dubner?

  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 were often college undergrads, were responding to the scrutiny of the professor who's running the experiment. We wrote about this in our book, Superfreakonomics, in a chapter called "Unbelievable Stories About Apathy and Altruism." So Catherine Echol.

• 4:53Speaker 01

  So Mike Arthur and I were interested and tried 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 foregoing some of their own income in order to give some money to somebody else.

• 5:23Stephen J. Dubner?

  When Echol 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 Echol, in designing a new experiment, addressed that problem.

• 6:07Stephen J. Dubner?

  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.

• 6:21Speaker 01

  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.

• 6:34Stephen J. Dubner?

  This gave Ekel 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% of the total amount due. This adds up to $477 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 Americans donate each year to charities. We happen to be an extraordinarily charitable nation.

• 7:19Stephen J. Dubner?

  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 Catherine Ekel thinking that maybe, just maybe...

• 7:46Speaker 01

  If there was a little bit of scope for people to direct their money, that would increase tax compliance.

• 7:54Stephen J. Dubner?

  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?

• 8:14Speaker 02

  Let's stir some competition by actually creating a market mechanism where the citizens can choose.

• 8:22Stephen J. Dubner?

  And what if you could also choose a small gift in return for your tax donation?

• 8:28Speaker 02

  So for all intents and purposes, it's no different from shopping on Amazon.

• 8:33Stephen J. Dubner?

  Would this actually work?

• 8:34Speaker 03

  I'm skeptical about how far you can get with the carrot approach.

• 8:39Stephen J. Dubner?

  Are you skeptical? You'll have a chance to figure it out right after this.

• 9:00Speaker 04

  From Stitcher and Dubner Productions, this is Freakonomics Radio, the podcast that explores the hidden side of everything. Here's your host, Stephen Dubner.

• 9:17Stephen J. Dubner?

  In case you hadn't realized, tax policy is a big deal.

• 9:21Speaker 03

  The impact of the tax system is absolutely pervasive.

• 9:27Stephen J. Dubner?

  That's Joel Slemrod.

• 9:28Speaker 03

  I'm a professor of economics at the University of Michigan.

• 9:32Stephen J. Dubner?

  Slemrod has been at it for a while, and he knows quite a bit about taxes.

• 9:37Speaker 03

  Yes, 95% of my papers have the word tax in some form or another.

• 9:43Stephen J. Dubner?

  And why such a devout interest in tax policy?

• 9:46Speaker 03

  It touches on just about everything. 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.

• 10:05Stephen J. Dubner?

  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 Wojciech Kapczuk 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

• 10:48Stephen J. Dubner?

  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.

• 11:06Speaker 03

  The best estimate we have is that for federal taxes, about 16% of what should be remitted is not.

• 11:14Stephen J. Dubner?

  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.

• 11:36Speaker 03

  The IRS guesses that if you're an employee and you have wages and salaries, the noncompliance rate is about 1%.

• 11:44Stephen J. Dubner?

  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.

• 12:10Speaker 03

  On the other hand, if your income is self-employment income, where there is no third-party reporting, they think that number goes from 1% to over 60%.

• 12:21Stephen J. Dubner?

  To over 60% noncompliance? How is that even possible? Well, note exactly what Joel Slemrod said.

• 12:29Speaker 03

  If your income is self-employment income, where there is no third-party reporting.

• 12:34Stephen J. Dubner?

  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,

• 13:17Stephen J. Dubner?

  and also tends to accrue to wealthier people who have greater resources for what you might call tax management. All this under-reported 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?

• 13:45Speaker 03

  Well, technically, the difference is that avoidance are legal ways to reduce your taxes, and evasion 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."

• 14:08Stephen J. Dubner?

  Unless you think tax evasion is a new problem, think again.

• 14:12Speaker 03

  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.

• 14:22Stephen J. Dubner?

  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,

• 15:05Stephen J. Dubner?

  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.

• 15:19Speaker 03

  They wanted to have a tax on real estate that was 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.

• 15:56Stephen J. Dubner?

  How did the glazers and glassmakers respond to the window tax?

• 16:01Speaker 03

  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 glazers had some business there.

• 16:32Stephen J. Dubner?

  I'm curious about where an action like that would fall on the line between avoidance and evasion.

• 16:39Speaker 03

  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.

• 16:56Stephen J. Dubner?

  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.

• 17:10Speaker 03

  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.

• 17:40Stephen J. Dubner?

  There's been a lot of talk lately, especially among Democrats running for president, of instituting new wealth taxes in the US. Knowing what we now know about professional lady rejectors and bricked up windows, you can imagine that the US billionaires targeted by a new wealth tax would likely prove quite adept at avoidance, if not outright evasion. That's 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.

• 18:23Stephen J. Dubner?

  For what it's worth, the economists behind Elizabeth Warren's wealth tax 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?

• 18:59Stephen J. Dubner?

  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.

• 19:19Speaker 03

  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.

• 19:34Stephen J. Dubner?

  So you're a more stick guy than carrot?

• 19:38Speaker 03

  I'm more of an incentive guy. So either carrots or sticks are incentives, but among incentives, I think the evidence suggests that sticks work better than carrots.

• 19:51Stephen J. Dubner?

  But Slimrod says the IRS doesn't have a very big stick.

• 19:55Speaker 03

  The real budget of the IRS is down over 20% since 2010. Audits are down a third.

• 20:03Stephen J. Dubner?

  This despite the fact that an audit can return as much as $4,500 per hour of IRS labor.

• 20:10Speaker 03

  In my view, I think it's the wrong direction for sure.

• 20:12Speaker 01

  And if you are caught, generally what happens is that then you have to pay them and a little bit more.

• 20:18Stephen J. Dubner?

  That, again, is Catherine Echol.

• 20:20Speaker 01

  So there's not a huge penalty associated with failing to pay your taxes.

• 20:25Speaker 04

  I mean, on one hand, the gospel is that everybody hates taxes.

• 20:29Stephen J. Dubner?

  And that is Kate Lambert, the University of Pennsylvania's Wharton School of Business.

• 20:33Speaker 04

  But on the other hand, I saw this data from the World Value 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 OK to cheat on your taxes. So as much as we hate them, we tend to comply.

• 20:48Stephen J. Dubner?

  Lambert is a marketing professor.

• 20:51Speaker 04

  Which means I study consumer behavior, which is... Basically, the psychology behind the way that people make decisions with money.

• 20:58Stephen J. Dubner?

  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.

• 21:07Speaker 04

  Well, there's been quite a bit of research done on social pressure. 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 could also seek to avoid negative emotions, like they don't want to feel shame.

• 21:25Stephen J. Dubner?

  But wouldn't it be nice if people could feel not just not bad about paying taxes, but actually feel good? That's essentially what Catherine Echol was going for in a follow-up to the experiment she did about disaster relief. In that one, you will recall.

• 21:41Speaker 01

  People would give almost as much to a government organization as they would to a private organization.

• 21:46Stephen J. Dubner?

  But how much of this effect was because people could specify where their money was going, something we can't do when paying taxes?

• 21:53Speaker 01

  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.

• 22:10Stephen J. Dubner?

  In this experiment, she compared what people were willing to give to the fund without knowing how the money would be spent.

• 22:16Speaker 01

  That's like really voluntary taxation because you have no control over how it's going to be used.

• 22:22Stephen J. Dubner?

  Versus the amount people would give if they could earmark their money for a specific purpose, cancer research, for instance, or affordable housing.

• 22:32Speaker 01

  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.

• 22:40Stephen J. Dubner?

  How much more? Echol's 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. It's an idea Kate Lamberton has also been studying.

• 23:00Speaker 04

  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.

• 23:17Stephen J. Dubner?

  There's another factor that can make paying taxes unpleasant.

• 23:20Speaker 04

  The other factor is the decoupling.

• 23:22Stephen J. Dubner?

  Meaning that paying in your tax money isn't coupled with any sort of tangible benefit the way it is when you buy something for yourself.

• 23:29Speaker 04

  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.

• 23:39Stephen J. Dubner?

  One way to change taxpayers' minds, or at least inform them about how their money's being spent, is to make the data accessible.

• 23:47Speaker 04

  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.

• 24:10Stephen J. Dubner?

  Here is the intervention that Lamberton and her colleagues came up with.

• 24:13Speaker 04

  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.

• 24:30Stephen J. Dubner?

  Again, I want to point out that the subjects of a lab experiment like this aren't necessarily 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%.

• 24:49Speaker 04

  If you let people have a voice in the way their tax dollars are spent, they're much more satisfied with paying them.

• 24:54Stephen J. Dubner?

  Okay, great. 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.

• 25:06Speaker 04

  It's hard because some categories are inherently more appealing. Perhaps they're more personally relevant to people.

• 25:12Stephen J. Dubner?

  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.

• 25:29Speaker 04

  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.

• 25:36Stephen J. Dubner?

  Meaning a taxpayer could specifically allocate just 10% of their total tax bill.

• 25:42Speaker 04

  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.

• 25:51Stephen J. Dubner?

  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 US, a process called participatory budgeting has been tried by some local governments and often-

• 26:07Speaker 04

  There's a vigorous debate about the way money should be spent. 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.

• 26:20Stephen J. Dubner?

  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.

• 26:29Speaker 04

  So we have a little box on our tax form that we can check to direct money to the presidential campaign fund. Right? 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.

• 26:45Stephen J. Dubner?

  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.

• 26:56Speaker 04

  So in the aggregate, what ends up happening in the US 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.

• 27:28Stephen J. Dubner?

  Okay, if you believe that giving people some power over their tax payments will increase tax payments, what's the next logical step?

• 27:36Speaker 02

  The hometown tax system is absolutely fantastic.

• 27:40Stephen J. Dubner?

  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. Freakonomics Radio is sponsored by Quince. You know those pieces in your closet that you find yourself wearing on repeat? The sweater that goes with everything? The perfect pair of pants or the tee you somehow always reach for first? Those are the pieces that make getting dressed easy, and that's what Quince does best. Quince focuses on high-quality wardrobe staples made with premium materials like 100% Mongolian cashmere, organic cotton, and merino wool. The styles are timeless, versatile, and designed to become the dependable pieces you reach

• 28:24Stephen J. Dubner?

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• 29:00Stephen J. Dubner?

  Freakonomics Radio is sponsored by Southern New Hampshire University. There's no hiding how convenient Southern New Hampshire University makes college. They offer over 80 career-focused graduate programs online. Classes have no set meeting times, so you can balance life and learning, and online tuition rates are some of the lowest in the country, making it all a little more manageable. A school this willing to work with you is worth the investment. Visit snhu.edu/freakonomics to learn more.

• 29:31Stephen J. Dubner?

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• 30:06Speaker 02

  Hello, mushi mushi.

• 30:07Stephen J. Dubner?

  That is Jesper Kohl. He's an economist by training, originally from Dusseldorf, Germany.

• 30:12Speaker 02

  I have been stuck in Tokyo for the last 35 years.

• 30:17Stephen J. Dubner?

  These days, he works for the financial firm Wisdom Tree. Before that...

• 30:21Speaker 02

  I first worked for three years in Japanese politics and then moved on into the world of finance, being the chief economist and head of research for both Merrill Lynch and JP Morgan.

• 30:34Stephen J. Dubner?

  So Kohl is fairly steeped in Japanese politics and economics, which, we should say, he adores.

• 30:42Speaker 02

  I mean, I've said this time and again, I want to be reborn as a 23-year-old Japanese.

• 30:47Stephen J. Dubner?

  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. The economic doldrums are severe enough that Prime Minister Shinzo Abe just last week announced a $120 billion stimulus package. But Jesper Kohl isn't worried.

• 31:16Speaker 02

  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.

• 31:40Stephen J. Dubner?

  That said, even an optimist of coal's intensity admits there are structural issues.

• 31:45Speaker 02

  The Japanese economy ultimately is very much a two-tiered economy in the sense that you've got the economic concentration in the megalopolises Tokyo, Osaka, and Nagoya. Those three centres effectively account for about three-quarters of Japan's employment and value-add creation. So the hinterland, the rest of the country, you know, 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,

• 32:28Speaker 02

  you find that almost 20 trillion go to redistributing funds from the rich urban centres into the regions of the economy.

• 32:40Stephen J. Dubner?

  By the way, those trillions Cole 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 urbanised. But in Japan, it is extreme. 94% 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

• 33:23Stephen J. Dubner?

  what's called a hometown tax system, or furosato noze. It allowed people to make donations to their hometowns, which, after the first 2,000 yen, or roughly $20, 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.

• 34:06Speaker 02

  It was brilliant in the conception, in the sense that there was a strong realization 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

• 34:47Speaker 02

  spirit in the sense that entrepreneurs are now actively marketing their products.

• 34:54Stephen J. Dubner?

  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 "donation" or "direction," that those local towns or prefectures would then send me some kind of gift, some kind of thank you.

• 35:16Speaker 02

  It was never a gift. It was never a gift. It was very conscious policy, 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'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.

• 35:52Stephen J. Dubner?

  Most of the products are food or beverages. Local delicacies, specialty seafood, microbrews. Elsewhere, a handmade sword by a master swordsmith, available for a tax donation of around $45,000. One agricultural town known for its high-grade beef and bell peppers attracted around $38 million in directed donations, the most of any municipal government, even though 90% of its donors had no connection to the town. In 2018, hometown tax donations in Japan totaled more than $4.5 billion. Jesper Kohl notes that one criticism of the program

• 36:37Stephen J. Dubner?

  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.

• 36:52Speaker 02

  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.

• 37:27Stephen J. Dubner?

  Is it made so difficult as a means of fraud prevention? Or is there another reason?

• 37:32Speaker 02

  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.

• 37:55Stephen J. Dubner?

  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 Cole likes to argue, drives the entrepreneurial spirit.

• 38:19Speaker 02

  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 microbrewer, trust me, the scheme is incredibly important.

• 38:52Stephen J. Dubner?

  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 Cole. 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. The system can also result in a wildly uneven redistribution of funds. For instance, the town famous for its beef and bell peppers it took in $38 million, it only has 70,000 households. And, of course, all that tax money flowing to the hinterlands

• 39:37Stephen J. Dubner?

  means that Japan's big cities, which continue to grow, are losing revenue. I asked Jesper Cole if there had been other unintended consequences.

• 39:46Speaker 02

  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.

• 40:31Speaker 02

  And as a result of that, they started to abuse the system.

• 40:34Stephen J. Dubner?

  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% of the tax donation itself. I asked Jesper Kohl, who went to college in the US, if he would suggest some version of the hometown tax here.

• 41:01Speaker 02

  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.

• 41:34Stephen J. Dubner?

  Kate Lamberton, the Wharton Marketing Professor, sees the Japanese hometown tax idea as tricky territory.

• 41:42Speaker 04

  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. So they've taken that intrinsic motivation and they've translated it into something that's extrinsic now.

• 41:56Stephen J. Dubner?

  This 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.

• 42:34Speaker 04

  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.

• 42:55Speaker 01

  Economists are really focused on incentives.

• 42:58Stephen J. Dubner?

  Catherine Echol again, from Texas A&M.

• 43:00Speaker 01

  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.

• 43:25Stephen J. Dubner?

  It's highly unlikely we'll ever see anything like Japan's hometown tax in the US. But what if, as both Echol and Lamberton would like to see, the US 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?

• 43:54Speaker 04

  You know, 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.

• 44:10Stephen J. Dubner?

  Lamberton even thinks it might improve the average citizen's relationship with the government.

• 44:15Speaker 04

  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 taxpaying process and the federal or state allocation process. Could it raise frustration? Sure. However, I think it's a very valuable conversation.

• 44:57Stephen J. Dubner?

  Coming up next time on Freakonomics Radio, several big-name Democratic candidates have already dropped out of the presidential campaign, but a former no-namer continues to turn heads. Here we have a businessman, out of nowhere, no prior political or military experience.

• 45:12Speaker 05

  The New York entrepreneur has gone from relatively unknown to a political force.

• 45:16Stephen J. Dubner?

  I'm Andrew Yang, and I'm running for president as a Democrat in 2020. Our conversation with the head of the Yang Gang, the man who wants to, quote, "make America think harder." That's next time on Freakonomics Radio. Freakonomics Radio is produced by Stitcher and Dubner Productions. This episode was produced by Matt Hickey. Our staff also includes Alison Kreglow, Greg Rippon, Harry Huggins, Zach Lepinski, Daphne Chen, and Corinne Wallace. Ben Shamen is our intern. We had help this week from James Foster and from our former intern, Ryan Kelly. Thanks also to several listeners who wrote in to tell us about the Japanese hometown tax, including Mark Zane, Jody Duboiski, as well as Jay Veenstra from Toyo University.

• 46:00Stephen J. Dubner?

  We love hearing your story ideas, so please keep them coming to [email protected]. Our theme song is "Mr. Fortune" by The Hitchhikers. All the other music was composed by Luis Guerra. You can subscribe to Freakonomics Radio on Apple Podcasts, Google Podcasts, Spotify, any podcast app. Our entire archive can be found exclusively on the Stitcher app or at Freakonomics.com, where we also publish transcripts and show notes. You can also sign up for our email newsletter there. We also publish every week on Medium a short text version of our new episode. Go to medium.com/freakonomicsradio. We can also be found on Twitter, Facebook, and LinkedIn. Freakonomics Radio also plays on most of your better NPR stations, so check your local station for details.

• 46:45Stephen J. Dubner?

  And thank you for lending us your ears. Talk to you later.

• 46:55Speaker 04

  Stitcher.

• 47:01Stephen J. Dubner?

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• 47:34Stephen J. Dubner?

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• 48:05Stephen J. Dubner?

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• 48:36Speaker 05

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