Nova workboard

a blog from young economists at Nova SBE

Fiscal Illusion

It happens that in several economic fields, analyses are based in microeconomic tools and way of thinking. We try to evaluate changes of one single variable keeping everything else constant. However, reality is far from this conceptual idea, and people’s preferences do not vary in terms of one thing only, but according to their perception of the whole environment surrounding them.

This is why it is always so difficult to derive conclusions about the effect of taxation on individuals and on their behaviour and choices, because we cannot just rely on the results of static analysis on some particular tax. It is important to keep in mind that individuals and society are not completely modelled and predictable.

I come here today to introduce the topic of fiscal illusion, which means that the average people, the electors, do not have perfect information about the costs of public action. The problem arises because the relation between public services and its financing is not obvious for citizens. Three major points contribute to this issue: the progressive taxes, because the ones who pay are not the ones who benefit the most; the strong presence of indirect taxes, creating an anesthetic feeling as to the total amount of taxes paid in a given period; and also the fact that the fiscal system in place is very complex.

These three motives prevent people from assessing the real cost-benefit of their choices. This lack of information promotes fiscal illusion, which can suggest an inefficient or unfair fiscal system, and ultimately an excess level of public intervention. As a consequence, if the electors do not understand the costs derived from government’s decisions, they will demand greater levels of intervention, relative to what they would ask for if they knew the true and higher costs required.

Some authors argue that, despite the sub-perception of the costs, there is also a sub-perception of the benefits resulting from public intervention, and so there is still the possibility of reaching efficient choices. Nevertheless, we have been witnessing that the growth in the public sector has been associated with the strong increase in indirect taxation. Besides, it is likely that this growth would not have been possible through an increase in direct taxation that would more vividly meet the conscience of people for the implicit costs of their choices, and make them refuse the rise in public expenditure.


Carolina Conde Rodrigues (#622)


Author: studentnovasbe

Master student in Nova Sbe

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