Economic Education Includes Addressing Tax Confusion

Economics isn’t just a course with supply and demand graphs and a quirky usage of “guns and butter.” It’s a discipline focused on incentives and responses, and we can see its impact all around us, shaping our world and our choices. This morning, you may have asked yourself, “should I stop for a coffee on my way to work?” while a lawmaker might have wondered, “should we modify the tax treatment of business income?” Both were economic decisions with broader implications.

Taxes are a cog in that economic machine, influencing small and large forces in the world around us. Increase taxes, for example, and you must reckon with the new incentive structure for hiring, investing, producing, consuming, and more. All these, in turn, have their own micro- and macroeconomic effects.

No matter the tax, people or businesses will respond. While most research demonstrates that if you tax something, you will get less of it, there are ways to minimize negative economic consequences from taxation.

Taxes on the most mobile factors in the economy, such as capital (machinery and investments), are more distortive and have the most negative impact on long-term growth. The inverse is also true, as taxes on factors that can’t easily be moved, like land, are more stable and less distortive. Understanding this can help us see past the ill feelings toward taxes and identify which ones are better than others.

Even the design of a tax can change its economic impact. Tax rates tend to receive the most attention, but the tax baseThe tax base is the total amount of income, property, assets, consumption, transactions, or other economic activity subject to taxation by a tax authority. A narrow tax base is non-neutral and inefficient. A broad tax base reduces tax administration costs and allows more revenue to be raised at lower rates.—what is taxed—can be just as important. Narrow tax bases can cause people and businesses to make decisions for tax reasons that they might not make otherwise, like saving less money or hiring fewer workers, and require higher rates to raise the same amount of government revenue. For example, a state with a narrow sales taxA sales tax is levied on retail sales of goods and services and, ideally, should apply to all final consumption with few exemptions. Many governments exempt goods like groceries; base broadening, such as including groceries, could keep rates lower. A sales tax should exempt business-to-business transactions which, when taxed, cause tax pyramiding.  base that has exemptions (like groceries) and sales tax holidays will rely on higher tax rates on taxable goods to generate the same amount of revenue. The resulting price increase can distort consumer decisions on what, or how much, to buy.

Another underappreciated factor that affects the economy is tax illiteracy. If a raise moves you from the 12 percent income tax bracket to the 22 percent and you believe your entire income will be taxed at the higher rate (it will not!), you may forgo a promotion or extra work hours. That decision will impact your spending, saving, and investment decisions too.

Economic and tax education is critical to interacting with our global economy, and you might expect to see educational priorities reflect the weight of the subject matter. Despite a growing number of states mandating financial literacy graduation requirements, some states have repealed requirements for economic education in recent years. But economic literacy and financial literacy go hand in hand.

If more than half of US taxpayers over 18 do not understand basic tax concepts, walking back economic education is quite a puzzling move. Understanding taxation, and economics broadly, helps prepare students for the mundane daily decisions like grabbing a “sweet treat,” inevitable tax questions, and what they can expect from decisions being made at the national level. And those who end up in elected office someday will need to design sound tax policies that generate revenue with minimal economic distortions.