A Choice Experiment on Taxes: Are Income and Consumption Taxes Equivalent?

Abstract

Income tax is considered equivalent to consumption tax in the public finance literature and there exits tax rates whose effective tax burdens are equivalent; 20% income tax and 25% consumption tax for example. However, it is not obvious whether people think in that way. We use a choice experiment to test the equivalence between income and consumption taxes. Subjects were asked to choose a preferred tax among 20% income tax and 25% consumption tax, 20% income tax and 22% consumption tax, and 20% income tax and 20% consumption tax under a given set of income and consumption parameters. We find that (1) when effective tax burdens are equivalent, subjects prefer income tax to consumption tax, (2) when the nominal consumption tax rate is higher than the nominal income tax rate, they prefer income tax, despite heavier tax burden, and (3) when nominal tax rates are identical, they prefer consumption tax. These findings imply that the subjects do not think theoretically equivalent taxes are equivalent because the subjects miscalculate the consumption tax burden. Moreover, our result shows that only one-third of the subjects appear to choose a tax regime based on accurately calculated tax burdens.