Tax time and loss aversion

A new paper today on the Henry tax review website (via core economics): ‘Behavioural economics and complex decision making: implications for the Australian tax and transfer system‘. A fantastic rundown for non-economists like me of the recent research of human behaviour and irrational economic decisions. It’s worth reading the first few pages, but the example contrasting risk aversion and loss aversion is fascinating:

The differential treatment of gains and losses can lead to anomalous decisions, since simply changing the way in which a decision is presented can change whether people view the consequences in terms of gains or losses (Tversky and Kahneman 1981). For example, in an experimental setting where people start out with $50 and are then offered the choice of either keeping $20 or taking a gamble with a 1/3rd chance of keeping all $50 and a 2/3rd chance of keeping nothing, most choose to keep the $20; if instead the choice is framed as losing $30 or a gamble with a 1/3rd chance of keeping all $50 and a 2/3rd of losing it all, most choose the gamble (De Martino et al. 2006). While these two scenarios are materially identical, simply changing the wording from ‘keep’ to ‘lose’ causes a significant proportion of people to change their behaviour.

The overall recommendations of the paper are about making tax returns ‘automatic’ by simply allowing people to approve a pre-filled tax return. It’s been covered already in the media, and it looks like it will be part of the ‘sell’ of a raft of tax reforms that might end up coinciding with a federal election in the second half of 2010.

If you ask me, an election is not really the time to try and implement sound, sustainable tax policy since there are bound to be some highly vocal losers, but then again, the best time for implementing it was probably during the budget surpluses in the middle of the decade and those days are long gone, not to return for at least five years.

What’s more, it looks like the review will not be tackling anything too explosive (negative gearing?) – changes to tax procedure and superannuation contributions don’t seem likely to provide victory to Turnbull (or Abbott or Dutton etc).

As for the idea itself, as someone who went three years without lodging a tax return because of the gnawing fear of having to uncover old receipts and clip together paperwork, it sounds fantastic to me. Certainly much cheaper than bribing everyone with $900 stimulus payments (which is what eventually got me to do it).