The Challenge of Transparency in Taxation

by Dr. Whitney B. Afonso

Part one of this article appeared in the November IOWA TRANSPARENCY NEWSLETTER.

Obstacles to Transparent Revenues

There are many obstacles to making government revenues transparent. Some have to do with the nature of the revenue instrument while others are the result of policy choices or tax administration. An underlying reason is the high cost to citizens of getting complete information on their total tax burden.[12] These costs, scholars have argued, lead citizens to choose to be “rationally ignorant” regarding their tax burden, which then allows governments to rely on deceptive or illusionary revenue instruments.[13]

The difficulty of acquiring this information is due to several factors. First, many taxes or fees are paid throughout the year, so citizens who want to capture their full tax burden must carefully monitor each tax payment. Sales taxes are collected on the purchase of most commercial items (not all items, though; for example, many states do not collect sales taxes on food, and in some states food is taxed at the local but not the state level). This means that many Americans pay sales taxes multiple times a day, so to know their total tax burden they would have to keep track of every receipt and be mindful of the sales tax rates in their jurisdictions.[14] This temporal spacing is most apparent in the sales tax, but other common examples are excise taxes (such as for gasoline or tobacco), tolls, park fees, and utility fees.

A second obstacle is the revenue complexity in the American system, in large part because there are a lot of taxes and fees that citizens pay. Fiscal illusion literature has shown that the tax system becomes more opaque as the number of revenue instruments grows. This problem is exacerbated by a reliance on taxes that are less visible and are spread out over time.[15] This becomes especially problematic when citizens must pay the same tax in multiple jurisdictions and to various levels of government. Because citizens may pay federal, state, and even municipal income taxes, they need to understand how their burden is spread over multiple governments.[16]

An additional obstacle is that some tax instruments are inherently less transparent than others. For example, the impact of sales taxes is attenuated by virtue of frequent payment, whereas property taxes, when not paid through escrow accounts, are more transparent because they are made known to taxpayers much less often, typically once a year. Many researchers of fiscal illusion theory point to the very transparency of property taxes as the primary reason why they are so unpopular. Similarly, income taxes should be transparent, but income tax withholding has made them more opaque.[17] Taxpayers are not confronted with their tax bill and may not keep track of how that burden accrues over the course of the year.

Why would government make its revenues less transparent? The fiscal illusion literature would say policymakers make them less transparent to make them more politically palatable. Another explanation is that as policymakers implement changes to ease administration, a loss of transparency is simply a side effect.

Strategies to Increase Transparency

What can be done to increase transparency on the revenue side? There are numerous strategies, but many are not feasible. For example, revenue systems would be more transparent if revenue instruments were used only by one level of government, not by overlapping jurisdictions. The more levels of government that share a tax base, the more difficult it is for taxpayers to track where their tax money is going, which in turn makes it difficult to hold the appropriate level of government accountable.[18] Another strategy would be to limit the number of revenue streams used at each level of government. If states were financed exclusively by income taxes, citizens could calculate their tax burdens more easily.[19] Under the current system, the citizen has to combine income tax burdens with sales taxes, excise taxes, fees, and so on.

There are more feasible ways in which governments could increase transparency. First, they could choose (if legally able) to rely on more transparent taxes. For local governments this could mean relying more heavily on property taxes and less heavily on sales taxes.[20] Increasing property taxes would most likely be met with a good deal of opposition from the public. The literature provides evidence that more visible and transparent tax structures lead to increased rationality of policy outcomes, so facing the political backlash may be worth it.[21] Furthermore, there is evidence that citizens are more willing to pay higher taxes (and trust elected officials) when fiscal institutions are more transparent.[22]

Other ways that government can increase revenue transparency are less structural in nature. Through increased citizen education and engagement, citizens can come to understand the ramifications of different revenue policies, including what their respective tax burdens actually are.[23] Governments could provide taxpayers with “receipts” for different tax instruments, which break down how much of a citizen’s taxes goes to each government program.[24] In November 2014, a bipartisan effort in Oklahoma, the Taxpayer Transparency Act, led to the creation of a taxpayer receipt.[25] It is intended to foster understanding of how taxes support state government and to enable citizens to hold their elected officials more accountable — ultimately leading to superior outcomes. However, citizens must first know their tax burdens to input them into the tax receipt form and receive a breakdown of what their taxes are paying for.

One of the few other states to adopt a taxpayer receipt is Utah.[26] The Utah system requires citizens to input their income tax burden on a receipt form, but it also allows citizens to estimate their own sales tax burden or provides an estimate based on a citizen’s income. While this system is imperfect — for example, it does not take into consideration family size or the individual taxpayer’s preferences or behaviors — it does provide a reasonable estimate of the taxpayer’s state sales tax burden, thereby increasing transparency of sales tax revenue. To make this process even more transparent, Utah could link to the receipt once income taxes are filed to use taxpayers’ personal information to populate the receipt, compare this information to the average burden in the state, and include estimates of all other taxes and fees.

Beyond creating a taxpayer receipt, few states and local governments are making an effort to increase revenue transparency. One exception is momentum toward shining a light on tax expenditures — that is, government spending through the tax code using various forms of tax breaks. While this approach does not directly help citizens understand their true tax burden, tax expenditures are not only a form of public spending; they also affect many aspects of tax policy and equity. For example, Massachusetts now publishes its tax expenditures budget, allowing taxpayers to view all tax expenditures and the magnitude of each. The budget focuses on expenditures from three categories of taxes: personal income tax, corporate income tax, and sales tax.[27] Vermont passed a law in 2013 mandating that the government must evaluate and provide justification for all tax expenditures.[28] While these efforts make substantial progress in making government more transparent, both governments and citizens need to do more to fight fiscal illusion as it applies to tax burdens.

Citizen outreach and education is difficult and costly. Governments have to use scarce resources to find ways to get citizens to engage. However, such efforts would be worthwhile if governments could inform citizens as to the scope of government activities, the reason government provides services and their benefits, and how much those services cost and how they are financed. Such knowledge, were it accessible, would allow citizens to make better-informed decisions about their desired level of taxes and services.

ENDNOTES:
[12] To a lesser extent, in many jurisdictions there is also a high cost to citizens of getting total revenue collections and expenditure information. This situation occurs most frequently in small, local jurisdictions where the budget may not be online and may not be readily available, complete, or clear.
[13] Anthony Downs, An Economic Theory of Democracy (Boston: Addison-Wesley, 1957).
[14] Tax salience is another concern regarding sales taxes. Research has shown that, because the cost of the tax is not presented with the cost of the good, people do not adequately factor in the additional cost that the tax adds and consequently do not correctly modify their expenditures.
[15] Visibility is understood as how clear the total burden of a given tax is.
[16] This issue can be even greater for individuals who work in more than one state or live and work in different states and are thus required to pay income taxes in multiple states and are aware of how their burden in one state interacts with their burden in another.
[17] They are less transparent also because of the complexity of the income tax code; the numerous deductions and tax expenditures make income taxes difficult to understand and navigate.
[18] Barry R. Weingast, “Second Generation Fiscal Federalism: The Implications of Fiscal Incentives,” Journal of Urban Economics 65, no. 3 (2009): 279–293; Lorenzo Boetti, Massimiliano Piacenza, and Gilberto Turati, “Decentralization and Local Governments’ Performance: How Does Fiscal Autonomy Affect Spending Efficiency?” FinanzArchiv 68, no. 3 (2012): 269–302; Paolo Liberati and Agnese Sacchi, “Tax Decentralization and Local Government Size,” Public Choice 157, nos. 1–2 (2013): 183–205.
[19] These strategies are being discussed exclusively from the perspective of transparency. There are reasons why governments may not want to do this — for example, the advised behavior of revenue diversification.
[20] This is becoming less and less feasible, however, and local governments are becoming increasingly dependent on sales taxes. Also, property taxes continue to make up the bulk of own-source revenue.
[21] Sausgruber and Tyran, “Testing the Mill Hypothesis of Fiscal Illusion.”
[22] James E. Alt, David Dreyer Lassen, and David Skilling. “Fiscal Transparency, Gubernatorial Approval, and the Scale of Government: Evidence from the States,” State Politics & Policy Quarterly 2, no. 3 (2002): 230–250.
[23] See Seth B. Payton and Sheila S. Kennedy, “Fiscal Magic: Outsourcing and the Taxing Power,” State and Local Government Review 45, no. 3 (2013): 189–195.
[24] Alternate ways that such receipts could be constructed include creating a profile of an average taxpayer in a particular income tax bracket and estimating and reporting the estimated taxes paid by this person. This would enable the citizen to see the scope of taxes (and fees) as well as get an estimate of his or her overall tax burden. This kind of receipt could also report how that money is being used. For an overview of taxpayer receipts and information on creating one, see Whitney Afonso, “Would You Like a Receipt with That? An Information-Sharing Tool for Enhancing Citizen Engagement,” Public Management Bulletin no. 8, February 2014, http://sogpubs.unc.edu/electronicversions/pdfs/pmb08.pdf.
[25] Taxpayer Transparency Act of 2014, 62 OK Stat. § 62-46 (2014).
[26] “Utah Taxpayer Receipt,” Transparent.Utah.gov, Utah Public Finance, http://utah.gov/taxpayer-receipt.
[27] See “Tax Expenditure Budget,” Governor’s Budget FY 2012, Commonwealth of Massachusetts, http://www.mass.gov/bb/h1/fy12h1/tax_12/hall.htm.
[28] See “Tax Expenditure Reports,” Vermont Department of Taxes, http://www.state.vt.us/tax/expenditurereports.shtml.

Whitney Afonso is an Assistant Professor at the School of Government at the University of North Carolina at Chapel Hill.

IOWA TRANSPARENCY NEWSLETTER is a monthly newsletter reporting on government transparency in our state.

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