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Paying Taxes Makes You Feel Good

New research suggests that, while we’d rather keep the money, we do derive some benefit from paying our taxes.
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Isn’t paying taxes annoying? Doesn’t it feel like you’re flushing your hard-earned money down the toilet?

A scholarly paper published just in time for the U.S. tax season suggests the answers are yes, and no, respectively.

“People would prefer to keep a dollar than pay it in tax,” the researchers write in the Journal of Economic Psychology, “but paying it in tax is not equivalent to throwing the money away.”

They argue that while we’d rather use the money to buy a flat-screen TV or take a vacation, we do derive some benefit from forking over cash to the government. Sure, there’s pain, but there’s also gain.

“Economists generally assume that human beings get ‘zero utility’ from paying taxes,” lead author Iwan Djanali, who co-authored the study with his adviser, Daimen Sheehan-Connor,  said in an interview. “Zero utility is econ-speak for, ‘You get no benefit out of it.’ Obviously, consumption gives you a lot of utility. If you buy an apple, it satisfies your hunger.

“We believe that paying taxes also gives you some utility, even though you’re enjoying less consumption. You get some ‘soft utility’ out of it. We call this ‘the warm glow.’ You feel good about helping others, even though you don’t get a direct monetary reward out of it.”

Djanali, a 26-year-old MBA student at Harvard University (the paper began life as his senior thesis at Wesleyan University) describes an experiment that provides evidence supporting this proposition, which he calls the “tax affinity hypothesis.” Sixty-six undergraduates were paid cash to perform a simple but tedious task: Shading in small circles. During six rounds of five minutes each, they were given a fixed sum for each circle they filled in.

For certain rounds, participants were paid at a higher rate — but they were also “taxed” on their earnings, and those taxes ate up all of the difference.

“For every participant, there is one round where there’s no tax, and you make four cents for every circle that you shade,” Djanali explained. “Then there’s another round where you’re paid five cents for every circle that you shade, but there’s a 20 percent tax. So the outcome, the after-tax wage, is the same — four cents per circle.”

The standard economic model would predict they’d work equally hard in both conditions, since the amount of money they walked away with was the same. Instead, they worked “significantly more in the presence of tax,” the researchers report.

This effect showed up across the board, but much more strongly in students whose major was something other than economics. “Economics majors apparently perceived less utility from paying taxes, which makes sense,” Djanali said. “In Econ 101, you’re taught you get zero utility from paying taxes. It’s ingrained in their behavior.”

Importantly, before the “taxed” rounds, participants read a short statement: “You may treat the tax deductions similar to the income tax you pay from your on/off campus jobs. Tax money is used by the government to fund public services and infrastructures. Tax also has a redistributive feature, as it channels some income from the rich to the poor.”

This reminder apparently acted as an incentive to productivity — even if the workers didn’t realize it.

Specifically asked if they thought they had worked harder in rounds with tax deductions, less than a third answered yes — “even though most of them did work harder in those rounds,” the researchers wrote. “This implies that people may respond to incentives even when they are not aware that they are doing so.

“Among those who said yes, most claimed that the added incentive of knowing that some money would go to a good cause influenced them to work harder.”

Might the workers have been responding only to the higher base rate as a sort of ego gratification, even if it didn’t show up in their paycheck?

Sheehan-Connor suggests not exactly. “Perhaps an individual who receives 5 cents per circle with a 1 cent per circle tax works harder than someone with a 4 cent per circle wage and no tax because he interprets that his contribution is ‘worth more’ due to the higher wage.  And that is exactly right from a social point of view: his contribution (per circle) is worth 4 cents of his own consumption and 1 cent of public consumption. A more traditional economic theory would say that he shouldn't care about that 1 cent of public consumption and thus shouldn't care about anything other than the 4 cents he is receiving. But our results show that he takes that extra cent that he does not receive into account.”

The researchers argue that these findings have practical policy implications. “One of the biggest issues in political debates around tax reform is whether higher taxes are a disincentive to work,” Djanali noted. “The argument is when you tax people so high, they’re less willing to work.

“What we’re saying is, yes, it would reduce incentive to work. But the reduction will not be as large as you might think, because people get some utility out of paying taxes. So this could have an impact on policy discussions.”

Then there’s the matter of transparency. Some economists suggest making taxes less visible, “so the impact on your behavior is less drastic,” Djanali noted. That argument favors value-added taxes, which are incorporated into the price of an item and thus less apparent to the consumer.

“Our findings suggest that [to the contrary] it might be better to make taxes more visible – to make it really clear what people are paying for,” Djanali said.

This approach contains risks, he conceded. Some of the people who consciously chose not to work harder when being taxed explained that they disagreed with certain things their money went toward, such as “funding war.”

These findings may help explain the public’s sometimes confusing attitude toward taxes. “When the question is asked in a straightforward manner, people almost always say they favor a cut in federal income taxes,” according to a report released last week by the American Enterprise Institute that looked at decades of U.S. polling data.

On the other hand, it adds, “Majorities usually say what they pay in federal income taxes is fair. In April 2011, 57 percent regarded the income tax they paid as fair, and 40 percent said they did not.”

Perhaps that perception of “fairness” — which seems to contradict the widespread opinion that the rich should be paying more — reflects the “warm glow” Djanali demonstrates. “The action of helping others,” he noted, sounding nothing like an economist, “makes you feel good.”