Thread by @econnaturalist

My UNDER THE INFLUENCE: PUTTING PEER PRESSURE TO WORK will be published on January 28 by Princeton University Press. In this thread, I’ll describe how behavioral contagion often creates powerful incentives to cheat. 1/
@PrincetonUPress @a_f13nd

No one is puzzled that someone might feel resentful when she sees rule-breakers gain at her own expense. The essence of the problem is captured in THE WAITER’S DILEMMA, an illustration involving servers who receive much of their compensation in the form of cash tips. 2/

Cash tips are difficult for the tax authorities to monitor. To simplify, I’ll assume that tips cannot be monitored by the tax authorities at all. Similar conclusions would follow even if tips could be monitored only imperfectly. 3/

Imagine that your choices were to work in a factory for a pretax salary of $1,000 a week, or to wait tables for a pretax salary of $500 a week plus weekly tips of the same amount. You consider the two jobs equally attractive apart from the matter of pay. 4/

Because you are honest, you expect to pay tax at the rate of 20 percent on income you earn from any source. Your after-tax pay would then be $800 a week no matter which job you took, and you would be indifferent between the two. 5/

But now suppose that many factory workers share your views about the two jobs except for one thing: They would feel no qualms about failing to declare tips that tax authorities could not monitor. 6/

These workers would want to switch to waiting tables, because they could avoid tax on half their weekly income. Their after-tax pay as servers would thus be $100 a week higher than what they were earning in the factory. 7/

The result would be an excess supply of people wanting to wait tables and a shortage of those wanting factory work. The inevitable response would be for wages to adjust until supply and demand in both labor markets were again in balance. 8/

If we assume for simplicity that foreign competition won’t permit higher wages in factory work, the entire adjustment would fall on table servers. 9/

In the likely event that restaurants could fill every available server position with people willing to evade taxes on tips, the new wage for table servers would then decline until their after-tax income became equal to the $800 after-tax income of factory workers. 10/

This would require a server’s salary to fall from $500 to $375 weekly. Together, the entire $500 in tips plus 80 percent of the $375 salary would add up to $800/week, the same as after-tax earnings in the factory job. 11/

The difficulty confronting an honest waiter is immediately apparent. If he pays tax on the $500 a week he receives in tips, his weekly after-tax salary will be only $700, or $100 a week less than he would have taken home as a factory worker. 12/

And since he could have taken home $800 a week as a fully tax-compliant factory worker, he might reasonably conclude that paying taxes on his tips would be unfair. 13/

This example, which I call THE WAITER’S DILEMMA, illustrates why pressures to cheat are even stronger than those that would arise in social isolation. 14/

We see many examples in which people resist the temptation to plunder even when confronted with golden opportunities.But such opportunities become dramatically more difficult to resist when one’s peers are seizing them without punishment. 15/

Behavioral contagion and traditional economic incentives reinforce one another strongly in the domain of tax compliance. High levels of tax compliance are a valued asset for a country, but become much more difficult to maintain in the face of behavioral contagion.16/

Congress began cutting the IRS budget sharply in 2011. The top 0.5 percent of income earners were already accounting for a fifth of all unreported income before those cuts began. Since then, the cuts have resulted in substantially reduced enforcement activities. 17/

Audit rates, for example, have declined sharply: only 1% of corporate returns in 2017 vs. almost 2% in 2012; only 4.4% of people earning over $1 million in 2017 vs. 12.5% in 2011. For corporations with assets over $10 million, 17.8% in 2012 vs. 7.9% in 2017. 18/

Many taxpayers, like waiters, resent feeling like chumps. Once widespread tax cheating becomes known, explosive feedback processes quickly ignite. The new enforcement environment clearly puts the American tradition of high tax compliance even further at risk. 19/

As IRS commissioner John Koskinen estimated in 2015, “… every $1 invested in the IRS budget produces $4 in revenue. The cumulative effect of the cuts in enforcement personnel since Fiscal 2010 is an estimated $7-8 billion a year in lost revenue for the government.” 20/

Koskinen’s estimates refer only to the direct effects of IRS budget cuts. The far more serious threat posed by reduced enforcement is that future revenue shortfalls will grow substantially larger as a result of behavioral contagion. 21/

Even with rigorous enforcement, opportunities to cheat will remain abundant. And because of behavioral contagion, the social cost of each successful act of cheating is a multiple of its direct private cost. 22/

Resources invested in efforts to thwart cheating thus yield far higher returns than generally supposed. The only people who stand to lose from such investments are precisely those we should most want to see lose. 23/

UNDER THE INFLUENCE: PUTTING PEER PRESSURE TO WORK describes simple steps that could harness the prodigious power of behavioral contagion to help solve the most pressing problems we face, chief among them, the climate crisis. 24/

It is available for preorder now:
amazon.com/dp/B07XKFLWCT/…