Barking up the wrong tree

Why might it be more efficient for Connecticut to change its sales tax rate from 6 percent to e^2 percent ?

Or more generally, why might using irrational numbers as tax rates be less distortionary than rational tax rates?

A hint comes from a great article by Amy Finkelstein, “www.mit.edu/files/3242">E-ZTax: Tax Salience and Tax Rates.” Her simple and powerful idea is that as the salience of tax rates declines, taxes will produce fewer distortions because taxpayers will not pay as much attention to the taxes.

The E-ZPass system is a perfect context for her to examine this hypothesis because E-ZPass users (she finds) pay less attention to tolls than people who have to pony up the cash from their wallets or purses. Comparing E-ZPass highways to non-E-ZPass highways, she finds that as the proportion of drivers making electronic payments increases “toll rates are 20 percent to 40 percent higher than they would have been under manual toll collection.”

High salience prices can drive us crazy. Levitt has written that one reason the public was so upset about high gas prices was that they have to spend so much time standing at the pump and watching the higher price. High pump prices are the antithesis of EZ-Pass pricing.

The “out of sight, out of mind” effect suggests that policies to lower salience tax might reduce consumption distortions. I find it liberating to buy goods in foreign currency when I have difficulty converting the price into dollars. So to begin with, sales tax rates that are nice round numbers, like 10 percent, are likely to be more distortionary (than rates with many decimals) because it is so easy calculate the tax burden.

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