HAPPY tax day, Americans! Dan Ariely, a Duke University behavioural economist, hypothesises that the complexity of the American tax code can lead Americans to spend too much by confusing us about how much money we really make:

In the US, we all know the gross amount that we make a year, but it's not as clear what our net income is. It's actually very complex because we get our salary, some of which the employer withholds, and we have no idea what we'll get back when tax day comes around. We can get back some money (depending on our expenses/deductibles), trends in our stock market portfolio, health care, etc. And we don't figure this out until April 15th (if not later) of the following year! And what are the consequences of knowing our gross yearly income and not much else? I think it causes us to feel richer than we really are and spend accordingly. Why would this be the case? There's a phenomenon we call the “illusion of money,” which is the idea that we typically pay attention to nominal amounts of money rather than real amounts. For example, the illusion of money means that if inflation is 8%, and you get a 10% raise, you would feel better than if there was no inflation and you got a 3-4% raise. The basic idea is that we pay attention to the nominal amount rather than the purchasing power, and don't realize what our money is really worth. In terms of our tax code, this suggests that in the US we focus on our gross yearly income, feel richer than we really are, and consequently end up spending more money.

This sounds right to me. People really are often surprised by the size of their tax bill or their return. I think this problem is especially acute if you have a regular gig and a regular paycheck from which various taxes are automatically withheld, but also a freelance side gig and periodic paychecks from which various taxes are not automatically withheld. At one level, you know full well that taxes eventually must be paid on freelance income. Yet the regular gig with automatic withholding trains you to think of your bank balance as what you have left over after taxes have been taken. If you're a bit dotty and/or you find money matters a stressful and exhausting hassle to be avoided unless absolutely necessary, it's very easy to forget that your checking-account balance is a lie and that you are but the temporary steward of a good chunk of "your" money, which really belongs to the state. This is why, in my household at least, tax time can be a bit of a horror. As the 1099s add up, we find ourselves panicking slightly, absurdly lamenting having made too much extra untaxed income which, as Mr Ariely suggests, caused us to feel richer than we really were, and this makes paying the taxes we owed all along (and should have planned for, but didn't because we are writers, not accountants, damn it) feel immiserating. Yeah, yeah. Cry me a river.

As Clive Crook says in this thoughtful appeal for tax simplification, "The lunatic complexity of the US tax code is proof of legislative incompetence. It is something you cannot gaze at too long without falling into despair." Somehow this makes me think of the menu at Wendy's. Like most fast-food restaurants, Wendy's offers a number of "meal deals" by which one can get a small discount off the price one would pay for the elements of the meal if purchased individually. However, there is also the $.99 menu, from which it is possible to buy close substitutes for the elements of the least expensive meal deal for even less. What we have here is a simple system of "price discrimination" by which Wendy's charges a little more to those willing to pay more and less for those who can't or won't pay more. On the face of it, the daunting complexity of the tax code seems similar. If you are highly motivated to minimise your taxes, you can hunt for every possible deduction for which you're eligible. And it seems that the more you need the money, the more motivated you will be. But finding deductions isn't nearly as simple as building a cheaper meal deal from the $.99 menu. Those taxpayers most likely to benefit from a smaller tax bill seem least likely to have the means to successfully sniff out all the deductions, to keep all the records required to claim them, or to hire someone who can do it for them. In actual effect, it seems that, in addition to confusing people about how much money they really have to spend, our stupefyingly complex tax code offers bigger breaks to those who are fastidious and intelligent and/or relatively rich. Mr Obama's proposal to eliminate deductions for the biggest income-earners partially addresses the unfairness of the tax code's inverted price discrimination, but it would be much better, and more fair, simply to eliminate all or most deductions and then adjust the rates.

(Photo credit: AFP)