Undercover Economist

Cheating death

Benjamin Franklin reminded us that death and taxes were life’s only certainties. Franklin was plain wrong. It is easy to avoid most taxes. If you don’t want to pay sales taxes, don’t buy things. If you don’t want to pay income tax, don’t earn money. If you’d rather avoid tax on petrol, ride a bike.

Typically the result of this perfectly legal tax dodging is what we economists call “deadweight loss” and what normal people might call a pointless waste. If you’re willing to pay £8.50 for a T-shirt but not £10, VAT will tip the balance between you buying and not buying. Because of the tax, you don’t get the shirt you wanted, the shop owner doesn’t collect the money she wanted – and, of course, the taxman doesn’t collect any revenue either. Everybody is worse off.

This is just another example of a favourite economic maxim: “People respond to incentives.” It’s cute, and true, but not always helpful. We need to know how much, and in which direction. Sometimes the question has huge policy weight. For instance, there’s an enthusiastic movement in the US that believes income tax cuts can raise revenue because they stimulate more work and more income and take a smaller slice of a much bigger pie. This view is implausible at anything other than very high tax rates. Cut taxes from 30 per cent to 25 per cent, and the economy needs to expand by a fifth before total revenues recover. That is an implausibly large expansion. In fact, it’s not even obvious that income tax cuts stimulate more work. They might indeed encourage people to work overtime knowing that they will keep more of the proceeds. They might equally encourage people to slack off: with take-home pay rising, why work so hard?

Still, it is unwise to underestimate the power of taxes to alter behaviour. Perhaps following Franklin, Margaret Mitchell commented in Gone with the Wind, “Death, taxes and childbirth! There’s never a convenient time for any of them.” She should have seen the economic research emerging from Australia. It turns out that death, taxes and childbirth can be and are rescheduled to suit the needs of Australian bank accounts.

The economists who realised this are Joshua Gans and Andrew Leigh, who have been publishing a series of papers and notes showing some suspicious patterns in Australian birth and death rates. Australia passed legislation to abolish estate taxes in 1978, meaning that anyone who died on or after July 1 1979 was entirely exempt, but anyone dying before that date would be fully subject to the inheritance tax, paid by about one in 10 of the departed. The fall in the death rate in late June of that year is quite striking, as is the sudden rise in early July. Gans and Leigh estimated that one in 20 likely deaths in the last week of June were postponed long enough to escape inheritance tax. With 90 per cent of estates too small for tax anyway, this suggests that fully half the likely taxpayers managed to escape death long enough to escape the tax too.

A happier example of the same phenomenon came in the summer of 2004. The Australian government announced in May that it would pay a “baby bonus” of A$3,000, about £1,250, to each family of a child born on or after July 1. The effect was unsurprising, at least to an economist: the number of happy events on July 1 was an all-time record, and twice as many as on June 30.

I shall bear this in mind. The Harford family is due to expand in September – or possibly October. We shall have to see what the incentives are before we decide.