Policy Forum: Cognitive Bias as a Factor in Determining the Efficiency of Sliding Scales

In tax law, sharp lines occur where a minimal change in a taxpayer's circumstances results in significantly different legal treatment. Sharp-line tests are criticized because they encourage taxpayers to alter their optimal behaviour for purely tax reasons, thereby producing deadweight loss. The most obvious alternatives to sharp-line tests are sliding scales, which operate by imposing tax proportionately on the basis of where taxpayers fall along a continuum. Scholars, including Edward Fox and Jacob Goldin, have suggested that the adoption of sliding scales in determining tax liability as opposed to the use of sharp-line tests could reduce deadweight loss in many contexts. However, the adoption of sliding scales generally comes at the cost of greater complexity, which can lead taxpayers to make systematic errors in selecting optimal behaviours and can also introduce cognitive biases. This article argues that smoothing existing sharp-line tests may not bring about predicted efficiency gains if such predictions rely on taxpayers behaving optimally. Rather, a more accurate determination of the change in deadweight loss occasioned by a shift from sharp lines to sliding scales would also account for the effects of cognitive bias. In order to illustrate the concepts dealt with herein, this article establishes a simplified example based on tax residence to explain the concepts of deadweight loss, sharp lines, and sliding scales in the context of Fox and Goldin's suggestion that sliding scales would be more efficient than sharp lines in many circumstances.