People complain a lot about taxes, their level, and their complexity. In virtually every Dutch national election campaign over the past 20 years, a simplification of the tax system has been promised. However, once in government, parties do not live up to this promise. Likewise, in many other Western countries, tax systems have become very complicated.
Complexity easily leads to confusion, which may result in suboptimal decisions – suboptimal for the individual taxpayer, and maybe also for society at large. In a recent study, we assessed whether people in the Netherlands are confused by the tax system. Together with Job Harms, we asked people: ‘How much more would you be left with if you earn an additional 100 euros gross income per month?’ We find that, indeed, many people hold strong misperceptions and that this differs between income groups.
People with a lower income underestimate how much more they will actually earn if they work more. More specifically, if they earn an additional monthly 100 euros, they will have 28 euros more left after taxes than they estimate themselves. People with a higher income actually overestimate how much they will be left with.
Moreover, we find that when people get a realistic perception of how much more they can earn when working more, they will start working more. So, these current misperceptions result in suboptimally low work hours and an unnecessarily high income inequality.
‘Informing people led those who were initially too pessimistic about how much extra they would earn to increase their working hours’
How people assess their gains after taxes
To study this, we did several surveys. First, we asked a representative sample of the Dutch working-age population to estimate how much their after-tax monthly income would increase if they earned an additional 100 euros gross income per month. We instructed them to take into account both the additional taxes that they may need to pay, but also possible changes in their tax credits and tax allowances (such as rent allowance, healthcare allowance, childcare allowance, and child budget).
We contrasted their estimate with how much they would actually gain, something we calculated using rich background information about their income, household composition, living situation, and so on. We find that the estimates of approximately 40% of the Dutch are ‘about right’. A third overestimates how much they would gain on net, while the remaining 25% underestimates it.
The latter group is concentrated among people with a low income. They tend to think that a higher gross income would not significantly raise their net income, whereas in fact it oftentimes does.
The effects of informing people
In the next step, we implemented three kinds of information interventions. For the first one, we provided general information about the Dutch tax and allowance system, describing how it works out for most people in three different income groups. The second intervention encouraged people to use a free web-based tool developed by the National Institute for Family Finance Information (NIBUD), where they can find more detailed and personalised information after describing their personal situation. Third and last, we provided some people with a combination of the two interventions.
We made sure to also have a control group that did not get any information. And we randomised all 2,500 respondents into the control and three information-intervention groups, enabling us to get reliable estimates about the effects of the information interventions.
Two months after the first data collection, we returned to all respondents and asked them to estimate how much their after-tax monthly income would increase if they earned an additional 100 euros gross income per month.
We concluded that the information interventions were effective in increasing the accuracy of people’s perceptions. Next, we also saw that informing people led those who were initially too pessimistic about how much extra they would earn to increase their working hours. On average, they started to work an additional 1.5 hours per week. This mostly applies to people with a lower income.
Hence, taking away confusion about taxes may be a way to reduce income inequality and, at the same time, increase overall labour hours. This is something that employers in both the public sector and private sector will appreciate, given the serious shortages in the Dutch labour market.
Policy implications
The research also gained political attention. Based on the research, Finance Minister Eelco Heijnen sent a letter to parliament informing them of the research. He explained that either more information was necessary or the tax system should be less complex. Based on this, a member of parliament for CDA raised questions on what should be done with the results of the research. The State Secretary of Finance, Eelco Eerenberg, responded that it was an ‘absolutely brilliant research’ and that he would ‘take it up’ in the Ministry’s agenda. This shows that economic research can have a real impact on policymaking.
About Roburt Dur
Robert Dur is Professor of Economics in the Department of Economics at Erasmus School of Economics.
About Arjan Non
Arjan Non is Assistant Professor in the Department of Applied Economics at Erasmus School of Economics.
- More information
For more information, please contact Ronald de Groot, Media & Public Relations Officer at Erasmus School of Economics: rdegroot@ese.eur.nl, +31 653 641 846.
