Behavioral biases and political actors: Three examples from US international taxation
Introduction
The literature on behavioral public finance has tended to focus on the biases of taxpayers. However, politicians and government agents are human as well and can be expected to show the same biases to which the public are all subject. Few works have studied empirically the heuristics applied by political elites, such as members of cabinet, party' leaders, or members of Congress, and they rarely' focused on the field of public finance (Vis, 2019; Bohmelt, Ezrow, Lehrer, & Ward, 2016; Kropp, 2010; Weyland, 2007; Laver & Sergenti, 2012). This chapter intends to make a contribution by' conducting several case studies from US international taxation.
Instead of comprehensive cost—benefit calculation, people rely on cognitive shortcuts in some cases. The availability heuristic is one of the most common cognitive shortcuts. People employ the availability heuristic when they assess how likely it is that something occurs by focusing on the ease with which they' can think of occurrences of it (Tversky & Kahneman, 1973). If certain risks are easy to recall, people are inclined to regard them as more serious and thus advocate for solutions (Sunstein, 2000).These easy-to-recall risks, however, are not necessarily risks with higher probability and greater harm than other risks. For instance, people tend to overestimate the risks of nuclear accidents due to media reports. Therefore, the availability heuristic helps people to arrive at decisions, but often causes overall misperceptions and behavioral biases, leading to bad policy decision-making.
Once the availability' heuristic has drawn decision-makers’ attention to certain issues, the representativeness heuristic shapes assessments of potential solutions’ quality and promise (Weyland, 2007).This cognitive shortcut causes people to overestimate the extent to which a small sample represents true population values, and thus draw excessively firm conclusions from a limited set of data. Even though a solution only works well under certain circumstances, the representativeness heuristic persuades people to ignore the premises and overly induces the solution’s applicability.
While voters and taxpayers are subject to these cognitive heuristics, politicians may also encounter the same problem. Theoretically, we can distinguish a situation in which politicians are rationally following the biases of the electorate (Noll & Krier, 2000) from situations in which their own biases come into play. Despite that political actors often possess more information and resources than common people, they also face more issues and have limited time, and thus tend to rely on cognitive heuristics for decisions without comprehensive cost-benefit analysis (Kingdon, 1989). Politicians’ own biases could be a more serious problem because they not only would be incapable of correcting the biases of the electorate, but also might make undemocratic and irrational policy decisions that rational voters or taxpayers might not intend to.
This chapter argues that political actors are subject to the availability heuristic in their decision-making. To make this argument, this chapter examines three examples of availability heuristic arguably influencing political actors and the unintended consequences of their reactions. The examples are all from US international tax rules: the Foreign Investment in Real Property' Tax Act (FIRPTA) (1980), the exit tax on US citizens who expatriate (2008), and the enforcement of withholding tax on dividend equivalents (2010).
The Foreign Investment in Real Property Tax Act (FIRPTA) (1980)
FIRPTA was enacted to tax foreign investors on their profits from disposition of US real properties. Before the enactment of FIRPTA, if American citizens, residents, or nonresidents who engaged in a US trade or business invested in US real property, their gains upon disposition of that real property' was usually taxable as capital gains.1 In contrast, certain foreign investors who did not engage in a US “trade or business” were exempt from tax on their US-source capital gains, including gains derived from sales of US real estate. That was the dichotomy FIRPTA abolished. Under FIRPTA, real estate profits are now taxable, no matter how limited a foreign investors US contacts may be. FIRPTA provided that gains realized by a nonresident alien individual or foreign corporation on the disposition of an interest in US real property would always be income “effectively connected” with the conduct of a US trade or business, and thus would be subject to regular rates of tax.[1] [2]
