According to Rosen et al's widely used public finance textbook: “…it is generally agreed that visible taxes are preferable to hidden taxes…."
It is, in some ways, a strange assertion. The standard economic analysis of taxation assumes that taxes' superficial aspects - things like who is legally responsible for collecting the tax - are largely irrelevant. Taxes change behaviour because they introduce a wedge between the before tax and after tax price of a good. A tax's impact on economic efficiency is a function of the size of that wedge. A tax's impact on equity depends upon the relationship between an individual's tax burden and his or her income. Neither efficiency nor equity depend upon visibility.
The argument that Rosen et al give in favour of visibility is, in fact, a political one:
Canadians need to know how much they pay in taxes in order to make informed decisions about the level of public sector spending that they are prepared to support. Public awareness of taxation levels is essential in achieving a reasonable balance between the private and public sectors’ provision of goods and services...
I'm not convinced. Here's why.
First, when it comes to taxes, what you see isn't always what you pay. For example, suppose you pay $700,000 for a new home in BC's Fraser Valley. Under BC's Harmonized Sales Tax (HST), taking into account BC's new housing rebate, $57,750 in HST will be added to the price of your home. $57,750 is the visible tax burden. But the actual tax burden might be far lower. People can only afford to pay so much for a new home. When a tax increases the after-tax price of homes, property developers a choice: keep the before-tax price the same, and leave some homes unsold, or lower the before-tax price. Tax incidence analysis predicts that the actual burden of a tax will fall upon whichever party is unable to move, or change their behaviour, in order to avoid that tax. When a tax is imposed on housing, the current land owner is the one who can't move. That's the person who actually bears the tax burden.
Visible taxes can lead to bad policy choices when a tax's visible incidence is different from its actual incidence. The average tax payer will vote for a tax/benefit scheme that appears to be in his or her interests - for example, increased health care spending financed by increased corporate income taxes - not realizing that the burden of the corporate income taxes might be shifted forward onto customers or backwards onto employees - in other words, right back onto the average tax payer.
Second, there's the problem of second best. A system with a mix of visible and invisible taxes can produce worse policy choices than a system which has only invisible taxes.
The federal GST or goods and services tax is a case in point. The GST is a value added tax. It replaced a particularly dysfunctional (small base, high rate) manufacturer's sales tax. Almost all economists considered the GST superior to the old sales tax. However it was extremely unpopular among the general public. The reason is simple: the old manufacturer's sales tax was invisible, so people couldn't tell how much they were gaining when it was eliminated. The GST was visible, so people could see the increase in their tax liabilities. As a result, they over-estimated the net impact of the GST on their tax liabilities. (To be fair, people weren't entirely stupid: manufacturers were slow to pass on the tax savings created by the elimination of the manufacturer's sales tax.)
Rosen et al argue that "Most economists view the visibility of the GST [goods and services tax] as one of its beneficial characteristics.” The political opposition to the GST and now the HST (harmonized sales tax) should make "most economists" reconsider this view.
A third argument against visible taxes is that they increase the efficiency cost of taxation. For example, the complex web of taxes facing by a middle-income earner - Employment Insurance and Canada Pension Plan premiums, federal and provincial income taxes, the loss of refundable sales and child tax credits, consumption taxes - make it hard for the average person to work out his or her marginal tax rate. If this complex tax web was replaced by a single flat-rate tax, people could easily work out their marginal tax rate - and might then decide it wasn't worth working.
A 2009 piece by Congdon, Kling, and Mullainathan that surveys a number of empirical studies argues that "When policymakers can choose to keep some taxes hidden from consumers, this will keep the elasticity low, which, other things equal, is desirable for efficiency purposes." The authors stop short of advocating stealth taxation, however, concluding that "Resolving the net welfare consequences of tax salience is thus an important future line of research."
Fourthly, to the extent that people dislike paying taxes, more visible taxes are more likely to be evaded. Evasion is a problem in part because it reduces the tax base. Thus, in order to maintain revenues, governments must levy higher taxes on those who comply, reducing economic efficiency and giving even more people an incentive to evade taxes.
Evasion and visibility pack a double-punch when it comes to entrepreneurs and the self-employed. Taxes are more visible to the self-employed than to employees -- sitting down and writing a cheque to the government is more noticable than having taxes deducted from from a direct-deposit pay cheque. The self-employed also have relatively more opportunities to avoid and evade taxes - by inflating home office expenses, for example, or accepting cash payment for services rendered. Susan Morse's study of small businesses in the US found "Most self-employed and small business taxpayers cheat on their taxes. In fact, in the aggregate, they fail to pay about half the tax they owe to the government, and this unpaid tax amounts to about $150 billion annually."
If sectors of the economy dominated by small businesses end up paying a lower tax rate, due to extensive tax evasion, than other sectors of the economy, this distorts the overall balance the economy.
Also, tax evasion is catching: I'm happy to pay my fair share, but I don't like paying taxes if everyone around me is evading.
A final argument for stealth taxation is that it facilitates budget balance. People want good things from their governments, like health care and old age pensions. But they don't want to pay taxes. So the temptation is to vote for spending initiatives and vote against any tax increases. When taxes become more visible, people become more aware of the taxes that they are paying, and lobby harder for tax cuts. The result: future generations are burdened with debt and taxes.
Now the argument could be made that in fact invisible taxes contribute to government debt - if the average voter realized how little he benefited from the Bush (Bush-Obama?) tax cuts, how much those tax cuts benefitted the richest Americans, and just how mind-bogglingly rich the richest Americans are, perhaps he would have voted against them. I don't know of any decisive evidence on this point, so if you disagree, feel free to say so in the comments.
Some degree of visibility in taxation is desirable - without information how the tax system works, and who bears the burden of taxation, it is difficult to make good policy decisions.
But a little goes a long way...
(This post draws from my latest column in the Globe and Mail's economy lab).