Taxes and Cheating
Will Rogers once said that “The income tax has made liars out of more Americans than golf” and I worry that he was correct. During his confirmation hearing to become the Treasury Secretary, it was revealed that Tim Geithner failed to pay Medicare, Social Security, and payroll taxes for several years while he worked for the International Monetary Fund (IMF). When asked by Senator John Kyl (R AZ) during the hearing about the (more than $40,000) “mistake,” which Geithner blamed on the tax software he was using, he replied, “it was very clear that this was an avoidable mistake… You’re right. I had many opportunities to see it.” But he didn’t, apparently, and that was that.
There are many problems here—one of which is the possibility of a double standard that allowed Geithner to get away with this entirely (I am not sure if this is the case or not). I suspect that if he had he been working for a domestic monetary agency, that is, the IRS, he would have faced heavy prosecution, fines, and almost certainly been fired. Also, as the future head of the Treasury, we might hope that he understands the tax code well enough to do his own taxes. Part of his defense, was, of course, that the code is too complex. Which is true, but in light of this, and his own errors, we might then hope he would be more aggressive about reforming the code, which he has not. The worst part of it, however, is the personal example he provided to the rest of the American taxpayers: do your taxes wrong, omit a few things, and if they catch you all you need is to pay it back — it’s basically okay.
I’m not calling for punishing Geithner (retribution isn’t necessarily helpful, not to mention it’s a little late), but as we draw closer to tax time, it’s worth recalling this incident and how it might affect the American public. In the research my colleagues and I have carried out on dishonesty, we’ve found repeatedly that people become more likely to lie and cheat after witnessing the dishonest behavior of others. In one of our experiments, we tested to see how participants would respond to a blatant act of dishonesty in their midst—would they think they too could cheat and get away with it, or would they perhaps straighten up and fly righter than ever? To find out, we gave participants 5 minutes to solve as many mathematical problems as possible (where they were instructed to find which two numbers out of 12 add up to 10).
In the control, where no cheating was allowed, the average student solved 7 problems, which gave them a pay off of $3.50 out of a maximum of $10 (if they solved all 20 problems). To see how witnessing and act of dishonesty would affect participants, we had one student—a confederate named David—stand up after only a minute and claim he’d solved all 20 matrices. The experimenter merely responded that in that case he could take his earnings and go. So how did the participants respond to this display when asked to self-report the number of matrices they solved? By cheating a whole lot: they claimed an average of 15 correct answers, more than twice the average score when cheating was not allowed.
Seeing someone cheat for their own benefit and then get away with it clearly has an impact on our moral behavior—loosening it to a substantial degree.
So, what does this experiment means for paying taxes? It means that the more we see politicians—the people who make our laws—fudge their taxes (which seems to happen continually), the more likely the rest of us are to adjust our understanding of what is right and wrong about paying our taxes, and do the same.
But there is hope. When we ran the same experiment with one slight difference, we found that dishonesty decreased dramatically. This time, instead of looking like all the other participants, who were students at Carnegie Mellon University, we had our confederate wear a sweatshirt that located him within a different social group. This time h was wearing a University of Pittsburgh sweatshirt (Carnegie Mellon’s neighboring and rival university). When the dishonest act was committed by a person from an out-group, we found that cheating decreased dramatically to the lowest level in all the experiments (participants claimed “only” 9 correct problems).
What this means is that if we think of ourselves and our politicians as being part of the same social group, we might follow their footsteps when we hear about another politician or celebrity who hasn’t paid taxes in years. On the other hand, if we don’t think that we belong to the same social group we might not feel more justified in our own moral indiscretions, and instead be extra careful not to be confused with this other, not so moral, social group.
So the moral of the story is: when you settle in to work on your taxes in the next few weeks, try not to think about the individuals who cheat on their taxes—and if you can’t avoid thinking about them, at least try to separate your own social group from theirs.
Go forth and be financially virtuous.
Dan Ariely is the James B Duke professor of Psychology and behavioral Economics at Duke University and the author of (the soon to be released) The Honest Truth About Dishonesty.
The Honest Truth About Dishonesty: How We Lie to Everyone - Especially Ourselves
Dan, is this attitude of “follow the leader” evident only when the leaders are setting a bad example, as in cheating? Or do people also follow the leader when the leader sets a positive example?
My excuse for doing my taxes properly: I don’t want to feel like a hypocrite when I complain about the crooks.
Great quote from Will Rogers and fascinating finding. Perhaps all we need to get momentum behind tax code reform is a common enemy? Unfortunately that seems to be the solution to all problems political.
Prof Ariely,
Let’s shift the discussion from income taxes to sales and use taxes where cheating is near ubiquitous. A tax is a tax. In this context a very large majority of consumers cheat on their taxes on a regular basis…they just ignore their own cheating or describe it as “not the same” or “not as bad” as what others do.
Consumers refuse to see themselves as part of the same group of tax cheaters as Geithner and Cain, but multi billion dollar online retail sales figures tell a different story. Uncollected sales and use tax on last year’s $194.3 billion of online sales, and this year’s projected $224.2 billion makes Geithner and Cain look like amateurs.
At the moment this doesn’t apply to folks living here in NH or in AK, MT, OR and DE where there are no sales and use taxes (woo hoo!). The other 45 states range from 2.9 to 7.25% — 3 to 11.5% if we include local surtaxes.
State officials know their constituents have been using online shopping to avoid sales and use taxes–something consumers can’t do when shopping at local retailers. And by “avoid” I mean consumers are not paying sales and use tax directly to their States as they are required to do for any qualifying taxable goods and services made online. Consumers like to spin this as “saving on taxes” because it sounds much better than “cheating on taxes.” Consequently, State officials are pushing to force online retailers to collect sales tax because State residents cannot be trusted to pay it themselves. Of course consumers are in an uproar about it…it’ll close a “savings loophole” that they’ve enjoyed for quite some time by making it more difficult to cheat on taxes.
It does not matter who consumers choose to do business with or where the businesses are located. What matters is where consumers live. Unless they happen to live in one of the five previously mentioned sales-tax free States, then they owe sales and/or use tax to their State Treasury for every taxable good/service they purchase online from an out of state supplier.
Thinking about those who cheat on their taxes in virtually unavoidable for many. After all, they see a tax cheat every time they look in a mirror.
Actually, some cities or boroughs within Alaska have local sales taxes, so not everyone Alaskan is off the hook. Anchorage doesn’t have a sales tax, but the Kenai Borough has a 3% sales tax, and several cities within its boundaries have a higher rate (Seward adds 4% for a total of 7%). Anchorage has a property tax on real estate, which likely reduces the cheating problem.
I suspect the same may be true for other communities within the four other states mentioned.
Hi Toby,
You’re absolutely right. When I mentioned local surtaxes I should have mentioned that a couple of the “tax free” states do have counties/cities/towns that collect a local tax. I believe here in NH we’re nearly completely free of state and local sales tax (special exceptions for certain grocery items and services).
Still, it’s safe to say that a vast majority of Americans are tax cheats in the context of the State and local sales tax they fail to pay each year for their online purchases. For some that may amount to thousands or tens of thousands of dollars annually.
Or, if you want to avoid cheating on your taxes, you could try volunteering at your nearest Federal Prison. I have been working on a vermicomposting project at our local Federal Prison Camp for years, and it has made me even more terrified of making a mistake on my taxes than I was before. Now I actually hold back a few of my business deductions just in case I get audited…
If I understand the problem you are addressing, it is that people are more likely to cheat if they witness someone else cheating, and since you would prefer that people not cheat, you would like to address this problem. That’s all very fine, and the observation isn’t particularly new, but your approach to the problem seems to come from a rather strange direction. It seems fairly clear that the straightforward solution is that people need to see serious negative consequences for the person who cheats, and then others will not cheat; so if Tim Geithner had, let’s be slightly nutty and extreme here, been publicly disemboweled for his actions, few would have wanted to follow his fine example. What happened instead is he was put in charge of the IRS. It is hardly surprising that people witness this and then think that they should cheat also. In other words, it seems that the problem you want to address is not that people witness others cheating and so then copy it, but that they witness others cheating _and_benefiting_from_their_cheating_ and so are more likely to cheat in turn. This seems to be a rather odd problem to address and the only motive that I can see for wanting to address it is that our political masters like to cheat and get away with it, but know that the consequences to society if all follow their fine example are not good. Question: why not do an experiment in which the person who cheats is caught and embarrassed in front of all, and see what the effect will be? Better, figure out a way for dealing with such fine leaders who want to be able to cheat but be considered different and so able to get away with it? Surely we do not want to return to the world where there is one law for aristocrats and another for the rest of us?
I think punishing people who cheat as deterrence doesn’t have a long-lasting effect. Be financially virtuous and set up examples for others to follow perhaps is more desirable for our society. Putting the question of legislative practicability aside, isn’t it much better to do something out of a sense of duty rather than fear?
Fear doesn’t deter people. Punishment makes the action into a risk assessment: how likely is it that I will be caught, how likely is it that I will be convicted, am I willing to risk the punishment. This is why we find social taboos to be better motivators than we find punishments, which is exactly why it’s called “coming out of the closet” and “admitting” to some kind of fetish, to being gay, to being (for the USA, at least) an atheist–there is no actual punishment for these things, but there *is* a terrible social penalty for them. There is no loss of rights or whatnot for any of these things (minus being gay), yet we find people unwilling to “admit” to this. Why? Because social penalties are far stronger than any other type of punishment possible.
Ehh, fear doesn’t work as a deterrent and it sets off a spiral of revenge. Apparently I also commented on the wrong post,so here’s a better reply on the usefulness of “justice/retribution” versus reformation.
http://www.economist.com/blogs/democracyinamerica/2011/07/norwegian-v-american-justice
Thanks Dan, your comments are always illuminating. IRS is an exemple of the discrepancy between consent as a social group, and compliance as individuals. Intelligence tests contain a question as to the purpose of taxes and most people can figure out something at least. But when it translates to MY part in it, the connection becomes loose and vague. Esp. in a social climate of high competition and low solidarity.
What’s amusing is the whole notion of “tax cheating” has been fostered by the politicians. Let’s see… spend like a drunken sailor; incrementally demand more and more money for your corruption, special interest groups, and bloated bureaucracies; build a tax system that punishes arbitrary behavior (e.g. buying apartments over houses); but one that rewards those who have the means to afford accountants to do clever things with money; “refund” money to those who have not paid into the system; exclude over 40% of taxpayers from any burden whatsoever; remove deductions for things like tuition above a certain level (so that those falling in this category effectively have a hidden tax increase); add ambiguous wording and voluminous levels of complexity.
Oh, and as Ellen S. reminds us–the threat of a gun to your head. The only reason I do my taxes with honestly is out of the fear of getting caught. When younger and more naive, I believed in paying an obligation to my country, and probably would still believe in it were it not blatantly obvious that doing so just make things worse. “Here, drunken uncle Jack, we know you have a drinking problem, here’s some more money. I hope you go get help for yourself.”
Why would anyone in their right mind think such a system is just and deserving of any respect? Perhaps if everyone was to cheat, and massively so, we’d be forced to fix the underlying corruption.
More realistically: were our federal government no larger than authorized or warranted, and were they not many, many decades and many many trillions deep in corruption, it would be feasible to institute a truly fair, low-burden tax program that would engender few cheaters.
At the very least, Geithner didn’t try to blame the software:
Grassley: “Which brand of tax software?”
Geithner: “I will answer that, but I want to say I take full responsibility. … It was TurboTax.”
http://latimesblogs.latimes.com/washington/2009/01/obama-cabinet-a.html
There is a difference between your experiment and tax evasion. One is voluntary (students agreed to participate in an experiment with a set of rules) while the other isn’t (when did I contract with the government or IRS to collect some of my income in return for “services”?).
Btw, I suspect there are many more liars as a result of bad legislation beyond just the income tax. Other examples: alcohol prohibition, drug prohibition, minimum wage and other labor laws, intellectual property laws,… There is a beautiful old-fashioned term to capture this behavior: scofflaws.
Dan et al,
There is a dual issues here:
Issue 1: “resoectable” people cheat and get away with cheating so my own personal cheating will reward me and is not morally beyond the pale ( and I am a rube and allowing myself to be taken advantage of if I sacrifice my own interests while everyone else is cheating except me.)
Issue 2: tax law is irrational and uninterpretable. The rules are not fairly applied nor were they conceived with a commitment to fairness. Especially since it’s possible to get away with it, it’s an obligation to subvert this inequable system to my advantage.
At this point, I think that this interpretation is so
widely held, it would be difficult to defend fair tax law.
Taxes are a source of revenue for the government to function at the level agreed upon by the governed. We forget that government cannot function without this support and that it is justified and necessary because we feel varying degrees of satisfaction with the outcomes taxes supports and have various degrees of faith in the fairness of the tax structure.
It seems to me that this is a special moral case that does not compare with other instances of cheating or the commission of generally accepted immoral acts.
I wonder if
the participants also expressed their faith or for that matter the lack of it, and how that affected their behavior?
Great post Dan!
Does anyone have a ranking of tax code complexity? As an American living in the Netherlands, I have a clear example of how terrible the US system is for taxpayers (but not accountants).
I wonder if the research experiments tell much about one’s honesty in doing their tax returns. Wouldn’t it have been better to examine a person’s honesty when the value is different. People do their taxes privately and may hear about tax evasion amoung the more affluent, but less about the average income earner. So I wonder if you examined that aspect, you may get different results.
For example, if the participants in the study were given upon arrival to the test an envelop of money (the amount only known by the tester and participant) and at the start of the test, the participants are informed that based on the test results, some of that money may have to be returned. The question is, would individuals receiving a larger ‘bonus’ more likely resort to cheating in order to retain the bonus than those who received less? Now if a ‘plant participant’ is incorporated in the research and this person finishes early with a good score and blurts out how much he/she is able to keep (a substantial ‘bonus’), how would that effect the rest of the participants who have received more or less of that ‘bonus’ and their honesty in completing the test?
It may be true that people will try to do the right thing more often if their surroundings encourage it, but the stakes of that action must have some effect on their individual decisions. I would suggest that people who believe they may ‘lose’ more than others by their actions might contemplate maneuvers to prevent that from happening.
Dear Dan
I recently read your book “Predictably Irrational” and it was a brilliant read. Consequently, I began to wonder about data collection techniques in your research (which is clearly data-intensive) and I came up with this thought: what if people react differently to online surveys than paper-and-pencil ones?
When people are online or specifically on a computer, it might be that they’re accessing a different personality. As in, people are not their facebook profiles are they? They’re different from what they project to the world. Similarly, a person with a computer-based job might have a ‘work persona’ and when he/she comes in front of a screen, that projection might still remain. Social networks and online-gaming have only served to detach the ‘real’ self from the online self don’t you think?
Although you’ve probably thought of all this already, if you haven’t you might want to give it some thought and hopefully it’s something that’ll benefit your research.
Your fan
Sayan Mukherjee
We learn by watching others act, not how they tell us to act.
What a maroon ! No wonder our financial system was crashed, with people like Timmy in charge. Turbo Tax doesn’t tell you anything – a Tax Guide or your tax preparer tell you that you have to remit these taxes (what is his income category – self-employed?!) It’s beyond belief to me that someone who is part of, and has hung around with, the 1% for the last 20 years does his own taxes. It’s also beyond belief that the IMF doesn’t have a payroll person who set up withholding for these taxes, either, or didn’t (doesn’t) send out a memo saying we aren’t withholding them and you need to remit them on your own.
I knew in Jan.2009, when Obama put the same bankster-types, who had just finished crashing the economy, back in charge – of THE ECONOMY – that we were screwed, and there was not going to be any hope or change in sight.
Great quote from Will Rogers and fascinating finding. Perhaps all we need to get momentum behind tax code reform is a common enemy? Although you’ve probably thought of all this already, if you haven’t you might want to give it some thought and hopefully it’s something that’ll benefit your research.
Everybody’s got to worry about something Dan. If worrying about people who “cheat” on their taxes is your choice, go for it. I’m more concerned about the bigger problem of the government looters who try to find new and creative ways to spend more of the money they take by force from those who think it’s their duty to pay. I like Doug Casey’s take on paying as little as you can get away with: “It is both ethically and practically imperative to starve the beast. The less cooperation of any sort we give the state – but especially the less money we give it – the less mischief it can get into. We’re unlikely to get politicians to vote for getting the state off our backs, out of our pocketbooks, out of our bedrooms, and out of other people’s countries as a matter of principle, but we could see the state get out of places it doesn’t belong simply for lack of funds. And if everybody treated minions of the state with the contempt they deserve, most of them would quit and be forced to find productive work. As Gandhi showed us, civil disobedience can not only be an ethical choice, but a very powerful force for change.”
You assert that the more we see politicians not paying their taxes, the more the rest of us adjust our understanding and might do the same.
Is there a difference dependent upon proximity or connection to the leader? I’m having a hard time believing that the potential negative influence of a cheat isn’t somewhat determined by this cheat being someone you work with or in your neighborhood more than some distant faceless politician.
I believe in one of Dan’s books there’s an example that answers your question. A student cheating on a college exam while wearing the school sweatshirt, versus dong the same while wearing the sweatshirt of a different school, and the influence it had on the other students in the exam. Generally the more you identify with a particular individual, the more you’re likely to believe it’s acceptable to behave the same way.