It was an (im)perfect illusion: Fiscal Illusion and You

Fiscal illusion, sounds catchy doesn’t it?  Does it sound more like something you would read about on an ophthalmology website than a blog on taxes?  Well, that is where you are wrong.  Fiscal illusion is a hypothesis surrounding the notion that citizens systematically misunderstand their true tax burdens and the benefits they receive from government-provided services. In other words, they do not understand how much they pay in taxes or the value of the services that government provides.

At the start of the last century, economist Amilcare Puviani hypothesized that the ruling class designs public tax and expenditure policies to minimize resistance from the dominated class. To do this, the ruling class intentionally overstates the benefits that the dominated class receives and tries to obscure the tax burden so that this dominated class will underestimate it. In democracies, this is usually born out when public officials try to make tax burdens appear lower than they actually are. Figure 1 shows what happens when citizens underestimate the cost of government and how much they pay for it.

As Figure 1 shows, if citizens are paying P1 for government and they know that P1 is their cost, then they demand X1 of services, landing them at point a.  However, if there is a fiscal illusion in place and they incorrectly believe that services cost P2, they will demand X2. Citizens believe they are on their demand curve at point c, but in reality they are off of their demand curve at point b.  Outcomes off the demand curve are suboptimal and inefficient.