Discussion Paper No. 966

A CHOICE EXPERIMENTON TAXES:ARE INCOME AND CONSUMPTIONTAXES EQUIVALENT?

Hirofumi Kurokawa
Tomoharu Mori
Fumio Ohtake

March 2016

The Institute of Social and Economic Research
Osaka University
6-1 Mihogaoka, Ibaraki, Osaka 567-0047, JapanA Choice Experiment on Tax: Are Income and Consumption Taxes Equivalent? *Hirofumi Kurokawa aTomoharu Mori b

Fumio Ohtake cMarch 28, 2016
Abstract
We test the equivalence of income and consumption taxes through a choice experiment. Under agiven set of income and consumption parameters, subjects were asked to choose among an
income tax of 20%, a consumption tax of 25% (which is an equivalent tax burden), a
consumption tax of 22%, and a consumption tax of 20%. Our results showed that subjects preferincome tax to consumption tax when the nominal consumption tax rate is higher than thenominal income tax rate. However, subjects tend to prefer consumption tax to income tax when
the nominal tax rates are identical. Our result, that subjects prefer income tax to consumption
tax despite a higher tax burden, implies the consumption tax miscalculation bias. The
consumption tax miscalculation bias is one where subjects miscalculate the amount ofconsumption tax as if it is declared by tax inclusive, as in the case of income tax, despite
consumption tax being tax exclusive. If the income tax burden is equivalent to the consumption
tax burden, subjects prefer income tax. This result implies that income and consumption taxes
are not equivalent due to the consumption tax miscalculation bias.
JEL classification: H24, C91
Keywords: Tax equivalence, Income tax, Consumption tax, Misperception of tax, Behavioral
and experimental economics*

We are grateful to Hidehiko Ichimura, Keigo Kameda, Akihiro Kawase, Daiji Kawaguchi, Yukinobu
Kitamura, Yutaka Kayaba, Daigo Nakata, Shuichiro Sasaki, Kan Takeuchi, Yosuke Tada, Yosuke Yasuda,and seminar participants at Chulalongkorn University, Meiji University, the 72nd annual meeting of theJapan Institute of Public Finance, the 10th Applied Econometrics Conference, the 19th annual meeting of
the Japan Public Choice Society, the 9th annual meeting of the Association of Behavioral Economics andFinance, the 93rd meeting of OEIO for their comments. Any remaining errors are ours. Our gratitude goesto the Japan Society for the Promotion of Science and the Institute of Social and Economic Research at
Osaka University for financial supports. JSPS Grant Numbers are, 13J05272 (H., Kurokawa), and
15K17083 (T., Mori), (A) 26245041 (F., Ohtake).
aGraduate School of Economics, Osaka University and Research fellow of JSPS. E-mail addresses:
nge007kh@student.econ.osaka-u.ac.jpb
The Research Institute for Socionetwork Strategies, Kansai University. E-mail: r148033@kansai-u.ac.jpcInstitute of Social and Economic Research, Osaka University. E-mail address:
ohtake@iser.osaka-u.ac.jp

11. Introduction
It is well known that consumption tax is equivalent to labor income tax in the public financeliterature. These taxes are theoretically equivalent taxes because the budget constrain with
consumption tax coincides with that with income tax. However, Blumkin et al. (2012) showedthat these taxes are not equivalent in a real-effort experiment. １ In their experiment, subjects
reduce their effort more in response to income tax than to equivalent consumption tax. This
result implies that people behave differently when confronted with one tax than whenconfronted with the other tax even though these taxes are substantially equivalent.
Such an irrational behavior is observed by a field experiment, an empirical study, and alaboratory experiment. Chetty et al. (2009) showed that, in comparison with tax-exclusive pricetags, tax-inclusive price tags reduce sales by 8%. ２ Finkelstein (2009) showed that the
introduction of electronic toll collection led to a reduced sense of financial burden and resulted
in an increase in toll fare. Moreover, some field experiments tested whether people behave
differently when they get information or advice about tax systems and benefits (Bettinger et al.
2012; Chetty and Saez 2013; Liebman and Luttmer 2011).
The misperception of taxes shown in Blumkin et al. (2012) and Chetty et al. (2009) resultsfrom ignorance about consumption tax. In the study of Blumkin et al. (2012), subjects reduce
effort under income tax, because their nominal earnings decrease and they cognize the income
tax. On the other hand, under consumption tax, subjects provide effort without considering theexistence of the consumption tax. Therefore, we can propose that the reason income andconsumption taxes are not equivalent is the consumption tax “ignorance bias.” In Chetty et al.’s(2009) study, consumers buy many more goods when price tags are tax-exclusive than when
they are tax-inclusive. This is because consumers ignore the consumption tax when goods areposted tax-exclusive price tags. The ignorance of this tax results in irrational behavior.
The misperception of taxes results from the miscalculation of taxes even when people take
into consideration the existence of taxes. For example, some research points to the confusion
between average and marginal income tax rates (de Bartolome 1995; Liebman and Zackhauser
2004; Feldman and Katuščák (2006). Abeler and Jager (2015) showed that subjects cannot
behave optimally in a complex progressive income tax system, but can behave optimally in a
１

Although there is no other experimental study that tests the equivalence of income and consumption
taxes, there are some experimental studies that test the tax incidence equivalence. This means the burdenof a tax on buyers and sellers is independent of who actually pays the tax. The tax incidence equivalenceholds in a simple market (Kachelmeier et al. 1994; Borck et al. 2002; Ruffle 2005). However, it does nothold in an ultimatum game (Kerschbamer and Kirchsteiger 2000) and voting (Sausgruber and Tyran 2005,2011).
２
Feldman and Ruffle (2015) showed a similar result in a laboratory experiment. Their subjects spend
more under tax-exclusive prices while total purchases under tax-inclusive and tax-rebate prices are notdifferent.

2simple progressive income tax system. We can interpret this as the income tax “miscalculationbias” leads to a misperception of taxes.
According to the results of Blumkin et al. (2012), we can deduce that the equivalence
between income and consumption taxes holds if people can properly take into consideration theexistence of consumption tax. However, previous research shows that the miscalculation ofincome tax also results in the misperception of tax. Thus, even if people take into consideration
consumption tax, the equivalence between income and consumption taxes might not hold if
people miscalculate the tax burden from either tax. For example, it is likely that many people
misperceive consumption tax being equivalent to income tax when the tax rates are the same.３
Assuming that all income is spent on consumer goods, if total income is $1 million and theincome tax rate is 10%, the amount of tax is $100 thousand. If the consumption tax rate is 10%,people often misunderstand it as being imposed on the amount of goods that already include tax
and believe that the amount of tax would be $100 thousand, though the correct amount of tax
would be $91 thousand. ４ Because people do not correctly understand that the way income tax
is applied is different from the way consumption tax is applied, people might not understandthat the amount of income tax is not equivalent to the amount of consumption tax when all
income spent on consumer goods and the income and consumption tax rates are the same. In
other words, consumption and income taxes might not be equivalent because of theconsumption tax miscalculation bias.
In Blumkin et al.’s (2012) study, the consumption tax ignorance bias is one of the
explanations why income and consumption taxes are not seen as equivalent and subjects preferconsumption tax to income tax. Another explanation is that their incomes are determined by theperformance of real-effort task. Durante et al. (2014) showed that subjects choose a lower
income tax rate when their incomes are determined by effort than when their incomes are
determined by luck. This result implies that subjects do not strongly prefer income tax when
their incomes are determined by a real-effort than when their incomes are determined randomly.
Therefore, subjects might tend not to prefer income tax, when their incomes are determined
randomly, and in these cases, income and consumption taxes are equivalent.
Our research question is whether income and consumption taxes are equivalent. If theequivalence does not hold, we can identify the following reason: Consumption tax ignorance
bias, consumption tax miscalculation bias, or income determination. In Blumkin et al.’s (2012)３

We define the income tax rate as 𝑡𝑡𝑦𝑦 and the consumption tax rate as 𝑡𝑡𝑐𝑐 . When all income is spent on
consumption goods, the income tax rate that brings in the same amount of consumption tax is 𝑡𝑡𝑦𝑦 =𝑡𝑡𝑐𝑐 ⁄(1 + 𝑡𝑡𝑐𝑐 ) < 𝑡𝑡𝑐𝑐 . The consumption tax rate that brings in the same amount of income tax is smaller than
the income tax rate because the denomination of the consumption tax is larger than the income tax.
４
Consumption tax is imposed on the before-tax price ($909 thousand in this case).

3

study, subjects endogenously determine their incomes and consumption under a given tax
system. In this paper, subjects choose a tax system under a set of given income and consumption
assumptions. Given an income distribution and the assumption that subjects consume all income,subjects choose a preferable tax system from two options. The set of two options includes three
types: a 20% income tax and a 25% consumption tax, a 20% income tax and a 22%
consumption tax, and a 20% income tax and a 20% consumption tax. ５ The first set of two
options is revenue neutral and the others are not revenue neutral. One tax choice for eachsubject is randomly selected and the choice is imposed on his or her payment. The sequence ofthe experiment is as follows: First, subjects choose tax systems before their incomes are
determined. Second, their incomes are determined randomly or on the basis of theirperformance in a real-effort task. Third, subjects choose tax systems again. Fourth, subjects
solve computational questions about cognitive reflection test (CRT; Frederick 2005) and theamount of income and consumption taxes. Finally, the imposed tax system is determined.
Our main findings are as follows: First, when the tax burden is equivalent, subjects prefer
the 20% income tax to the 25% consumption tax. Second, subjects prefer the 20% income tax tothe 22% consumption taxes, even though the 22% consumption taxes are a lesser burden thanthe 20% income tax. Third, when the tax rates are the same, 20%, subjects prefer the 20%
consumption tax, which is a lesser burden than the 20% income tax. Fourth, subjects tend toprefer consumption tax to income tax when their incomes are determined by a real-effort thanwhen their incomes are determined randomly.
The equivalence between income and consumption taxes isn’t hold by the consumption tax
miscalculation bias, because subjects prefer the 20% income tax to the 25% consumption tax.
Subjects calculate the tax burden of a consumption tax in the same way as an income tax.
Subjects do not prefer consumption tax, which has a higher nominal rate than income tax.
Hence, subjects evaluate the tax systems not on the real tax burden but on the nominal tax rate.
Furthermore, even when the financial burden of consumption tax is smaller than the financial
burden of income tax, subjects prefer the 20% income tax to the 22% consumption taxes
because the nominal consumption tax rate is higher than the nominal income tax rate. In thissituation, subjects feel a larger financial burden from consumption tax. When the nominal
consumption tax rate is identical to the nominal income tax rate, subjects feel the same burden
５

It seems that the consumption tax (20–25%) that we use in the experiment is higher than the
consumption rate (8%) that is imposed on consumption goods at the time of conducting the experiment inJapan. However, the experimental consumption tax rate is not a high enough consumption tax in Europe.
Furthermore, Braun and Joines (2015) showed that if the government of Japan corrected fiscal imbalances
using only an increase in the consumption tax, the consumption tax rate needs to gradually rise to 46% in
2100 and then eventually fall to 36.37%. Therefore, the consumption tax (20–25%) is important for Japanin the future.

4

for both these taxes and do not prefer income tax if the amount of tax is equivalent. This result
is consistent with that of Blumkin et al. (2012) under the tax rate illusion.
We also find that only one-third of the subjects evaluate the tax system based on the tax
burden. One-third of the subjects, who are supposed to prefer a consumption tax over an income
tax if tax owed is equivalent, prefer the 20% income tax to the 25% consumption tax. They are
consumption tax miscalculation-biased subjects. One-third of the subjects prefer an income tax
independent of tax rates. The result that subjects prefer the 20% income tax to the 25%
consumption tax implies that they seemingly prefer an income tax to a consumption tax whenincome and consumption taxes are equivalent. However, if we regard the miscalculation biased
as subjects who prefer a consumption tax when these taxes are equivalent, the proportion
preferring an income tax nearly equals that preferring a consumption tax.
Our result implies that one of the origins of tax misperception is the fact that people
incorrectly understand the definition of tax. Many people miscalculate the amount ofconsumption tax because they misunderstand that consumption tax is declared by tax inclusive,
as in the case of income tax, despite consumption tax being tax exclusive. If we standardize alltaxes as being tax inclusive, people can correctly calculate the amount of taxes and makeunbiased decisions. Even if people consider the existence of taxes, they are likely to
miscalculate the amount of tax. Taxes should be presented in ways that are difficult to
miscalculate.
The remainder of the paper is organized as follows: Section 2 describes the experimental
design, and section 3 explains the hypothesis. We present experimental results in section 4.
Section 5 discusses results and presents conclusions.

2. Experimental Design
We conducted the experiment in December 2015 with 105 student subjects at Osaka
University. We conducted four sessions: Each session involved 25, 28, 25, and 27 subjects. The
average duration of the experiment was 60 minutes. The average payment per subject was¥2,767 (approximately USD 22 at the time of the experiment). The experiment was
programmed and conducted using z-Tree (Fischbacher 2007).
In the experiment, subjects chose a preferable tax system from two tax systems, given an
income distribution and the assumption that subjects consume all income. Figure 1 shows thesequence of our experiment. After reading the instructions, subjects chose between two tax
systems three times before their incomes were determined. After subjects chose the tax system,
their incomes were determined and then they again chose a tax system between two options.
After the tax choices, subjects solved computational questions. Finally, if subjects completed theexit survey, one tax choice for each subject was randomly selected and the total consumption5was converted into his or her payment under the tax choice. ６
We define income distribution as {1600, 2200, 2500, 3100, and 4500 points}. The numberof subjects for each income level was designed to be even by each session. We assumed that
subjects consume all income. The set of tax systems is as follows:
1) A 20% income tax or a 25% consumption tax
2) A 20% income tax or a 22% consumption tax
3) A 20% income tax or a 20% consumption tax
The time restriction before their incomes were determined was 120 seconds and that after theirincomes were determined was 60 seconds. The before-tax income and consumption is displayedin the second tax choice.
Table 1 shows the after-tax income and consumption. We explained that income tax is a tax
in proportion to income. When we define an income as 𝑌𝑌 and the income tax rate as 𝑡𝑡𝑦𝑦 , theamount of tax is 𝑡𝑡𝑦𝑦 𝑌𝑌. For example, if the income tax rate is 20%, the amount of tax for the firstquintile is 320 (= 0.2 × 1600). We explained that consumption tax is a tax in proportion to
consumption and the tax-inclusive amount of consumption does not change even if theconsumption tax is imposed; the net (substantial) consumption subtracts the amount of tax fromthe consumption in responding to the income. When we define consumption including tax as
𝐶𝐶𝐶𝐶 and the consumption tax rate as 𝑡𝑡𝑐𝑐 , the amount of tax is (𝑡𝑡𝑐𝑐 ⁄(1 + 𝑡𝑡𝑐𝑐 ))𝐶𝐶𝐶𝐶. For example, if

the consumption tax rate is 25%, the amount of tax for the first quintile is 320(= (0.25⁄(1 + 0.25)) × 1600).

The provisional incomes were assigned to subjects in two possible ways: randomly(henceforth “Random”) or on the basis of their relative performance in a real-effort task
(henceforth “Real-effort”).７ These two methods were designed to mimic some determinants ofeconomic success in real life. ８ Random mimics luck and Real-effort mimics hard work. We use
a slider task (Gill and Prowse 2012) as a Real-effort task. ９ Figure 2 shows the screen of aslider task. There are 48 sliders positioned at 0 at the first time. By using the mouse, subjects
adjusted the slider to position it at 50 as much as possible. The time given to do this was 120
seconds. After the first tax choice task, subjects practiced the slider task twice. After the practice,６

We converted 1 point into ¥1.
53 subjects were assigned to Random and 52 subjects were assigned to Real-effort income groups.
８
Other determinants are family background, acquired knowledge, and ability (Durante et al. 2014).
９Gill and Prowse (2011) point out four advantages of a slider task as a real-effort task compared withother real-effort tasks. First, the slider task is simple to understand and does not require pre-existingknowledge. Second, the slider task is identical every time, unlike solving math problems, negotiatingmazes, or solving anagrams. Third, the slider task has little randomness. Fourth, there is no scope forguessing in the slider task.
７

6

subjects started into the main part of the slider task and their incomes were determined by theirrelative performance. １０
Subjects solved computational questions before the exit survey. Congdon et al. (2011) and
Abeler and Jager (2015) showed that cognitive and computational ability are related to tax
perceptions. To measure cognitive ability, we used a CRT test (Frederick 2005). １１ To identify
whether subjects understood the manner of tax calculation, we asked comprehension questions
about each tax calculation. One question (TaxQ1) concerned income tax: “If an income tax rateis 20%, which alternative presents the correct answer for calculating the tax owed by someone
whose income is ¥1 million?” The other question (TaxQ2) concerned consumption tax: “If aconsumption tax rate is 20%, which alternative presents the correct answer for calculating the
tax owed by someone whose consumption is ¥1 million?” Subjects chose the following
alternatives: “1 million × 20⁄80,” “1 million × 20⁄100,” “1 million × 20⁄120,” and “noneof the above.” The correct answer for TaxQ1 is “1 million × 20⁄100.” The correct answer for
TaxQ2 is “1 million × 20⁄120.”In the exit survey, we asked subjects hypothetical questions about tax: “Suppose theamounts owed in income tax and consumption tax are equivalent, which tax do you prefer ifeither must be imposed?” Subjects chose the following alternatives: “I’d like to impose an
income tax,” “It’s indifferent for me,” and “I’d like to impose a consumption tax.” Thishypothetical question can elicit direct preferences without miscalculating the amount of tax
owed. In the exit survey, the subjects who chose “I’d like to impose an income tax” were
defined as a subject who prefers income tax in the exit survey and those who chose “I’d like toimpose a consumption tax” were defined as a subject who prefers consumption tax in the exit
survey.
Table 2 shows individual characteristics and computational abilities of subjects. Somecharacteristics are not balanced between treatments. We will control individual characteristics inthe subsequent empirical analysis. About 40% of subjects calculated all answers correctly in the
CRT test, and only 20% of subjects calculated consumption tax correctly. The proportion ofsubjects who prefer consumption tax in Random was significantly higher than that of subjects
who prefer income tax (𝑝𝑝 = 0.067). The proportion of subjects who prefer consumption tax inReal-effort was slightly higher than that of subjects who prefer income tax, but this finding is

not statistically significant (𝑝𝑝 = 0.381).
１０

Before the main part of the slider task, subjects forecast their income rank in the main part.
We use three well-known questions. CRT1: A bat and a ball cost ¥11,000. The bat costs ¥1,000 morethan the ball. How much does the ball cost? CRT2: If it takes 5 machines 5 minutes to make 5 widgets,
how long would it take 100 machines to make 100 widgets? CRT3: In a lake, there is a patch of lily pads.
Every day, the patch doubles in size. If it takes 48 days for the patch to cover the entire lake, how long
would it take for the patch to cover half of the lake?

１１7

3. Hypotheses
In this experiment, income 𝑌𝑌 equals total consumption including tax, 𝐶𝐶𝐶𝐶, so that if theamount of income tax is equivalent to the amount of consumption tax, the relationship between
the income tax rate 𝑡𝑡𝑦𝑦 and the consumption tax rate 𝑡𝑡𝑐𝑐 is𝑡𝑡𝑦𝑦 =

𝑡𝑡𝑐𝑐< 𝑡𝑡𝑐𝑐 .
1 + 𝑡𝑡𝑐𝑐

Hence, the nominal consumption tax rate is higher than the nominal income tax rate when the
consumption tax burden is equivalent to the income tax burden. The 20% income tax is
equivalent to the 25% consumption tax. The consumption taxes (22% and 20%) are less of aburden than the 20% income tax. Therefore, if subjects can rationally calculate the amount oftax, the hypothesis is as follows:
Hypothesis 1A: Subjects can rationally calculate the amount of tax.
If subjects can rationally calculate the amount of tax, they choose a less burdensome tax system:
The 20% income tax is indifferent to the 25% consumption tax. Subjects choose theconsumption taxes (22% and 20%), which are less burdensome than the 20% income tax.
However, subjects are likely to miscalculate the amount of consumption tax, which suggeststhat they do not understand the difference between the definitions of consumption tax andincome tax. Subjects may not understand that consumption taxes are imposed on the before-tax
price. If subjects misunderstand that consumption taxes are imposed on the after-tax price, theyevaluate the tax systems on the basis of comparing the nominal tax rates. Therefore, if subjects
miscalculate the amount of consumption tax, the behavioral hypothesis is as below:
Hypothesis 1B: Subjects miscalculate consumption taxes.
If subjects calculate the amount of consumption tax like the amount of income tax, they evaluate
the tax systems on the basis of comparing the nominal tax rates. Subjects choose the 20%
income tax, which seems to be less burdensome than the consumption taxes (25% and 22%).
Subjects are indifferent in choosing between the 20% income tax and 20% consumption tax.
Blumkin et al. (2012) showed that income and consumption taxes are not equivalentbecause subjects reduce their effort more in response to income tax than to an equivalentconsumption tax. This is because subjects ignore the existence of consumption tax when they
provide their effort in the case of imposed consumption tax, though they cognize the existenceof income tax when they provide their effort in the case of imposed income tax. Therefore, if we8get the same result as that of Blumkin et al. (2012), the hypothesis is as below:
Hypothesis 1C: Subjects ignore consumption taxes.
If subjects ignore the consumption tax, they choose the consumption taxes (25%, 22%, and 20%).

Subjects in Blumkin et al.’s (2012) study might have not preferred income tax because
income was determined on the basis of their performance of a real-effort task. Durante et al.
(2014) showed that subjects support a lower income tax when their incomes are determined on
the basis of their performance rather than when their incomes are determined randomly. This
result implies that subjects do not prefer income tax when their incomes are determined by theirperformance of a real-effort task.
Hypothesis 2
Subjects do not prefer income tax when their incomes are determined on the basis of theirperformance of the real-effort task (Real-effort income group) as opposed to when their incomesare determined randomly (Random income group).

4. Experimental Results
In this section, we first show the proportion of each chosen tax to test two hypotheses.
Second, we classify subjects based on the tax choice patterns.

4.1. Tax Choices
In Table 3, we regress a set of experimental conditions on tax choices. The dependent
variable is 1 if a subject chooses an income tax and 0 if a subject chooses a consumption tax.
We use a linear probability model with the standard error clustered by subject. When subjects
chose between the 20% income tax and the 25% consumption tax, 86.8% chose income tax
before their incomes were determined (column 1). There was no difference in preference for tax
systems before and after their incomes were determined. Compared with the Random income
group, the proportion of subjects choosing income tax in the Real-effort income group was lessthan 13.7 percent points. The proportion of subjects choosing income tax is significantly higher
than 50% in all cases. This result implies that subjects prefer the 20% income tax to the 25%
consumption tax, though the amount of the 20% income tax is equivalent to that of the 25%
consumption tax. The result supports Hypothesis 1B. Subjects do not prefer an income tax thathas a higher nominal tax rate than an equivalent income tax because subjects calculate thefinancial burden of consumption tax in the same way as that for income tax.
When subjects chose between the 20% income tax and 22% consumption tax, 71.7% chose9

income tax before their incomes were determined (column 2 of Table 3). There was nodifference in preference for tax systems before and after their incomes were determined. The
proportion of subjects choosing income tax was significantly higher than 50% in all cases. This
result implies that subjects prefer the 20% income tax to the 22% consumption tax. The result
also supports Hypothesis 1B.
When subjects chose between the 20% income tax and the 20% consumption tax, 39.6%
chose income tax before their incomes were determined (column 3 of Table 3). There was nodifference in preference for tax systems before and after their incomes were determined.
Although subjects are indifferent to the choice between income tax and consumption tax before
their incomes (Random) are determined, the proportion of subjects choosing income tax issignificantly lower than 50% in other cases. This result implies that subjects tend to prefer the
20% consumption tax to the 20% income tax when the nominal tax rates are identical. Under the
consumption tax miscalculation bias, the result supports Hypothesis 1C that subjects preferconsumption tax because of the consumption tax ignorance bias.
In the regression in Table 4, we treat parameters of consumption taxes as independent
variables and the dependent variable is an income tax choice dummy in the same manner as in
Table 3. We control another set of experimental conditions, individual characteristics, andcomputational abilities on tax choices. Subjects do not prefer the 20% income tax to the 20%
consumption tax and the 22% consumption tax compared with the 25% consumption tax(column 1). Subjects in the Real-effort group do not prefer income tax to consumption tax morethan subjects in the Random group. This result supports Hypothesis 2. These results do notchange with controlling individual characteristics (column 2). In column 3, we control
computational abilities. Subjects who are all correct in CRT questions prefer an income tax overa consumption tax. Even subjects who can correctly answer the CRT questions miscalculate theamount of tax burden. Subjects who are all correct in TaxQs tend to choose the 22%
consumption tax over the 20% income tax. This result implies that subjects who misunderstandthe definition of a consumption tax prefer the 20% income tax to the 22% consumption tax,
despite the 20% income tax having higher tax burden than the 22% consumption tax.

4.2. Subject types
Table 5 shows the subject types based on the tax choice patterns. We defined “strong CT
lover” as a subject who always chose consumption taxes rather than income tax. We
defined “IT lover” as a subject who chose income tax when the tax burdens are equivalent andchose consumption taxes 22% and 20% otherwise. We defined “miscalculation biased” as a
subject who chose the consumption tax 20% only when the nominal tax rates are equivalent andchose income tax otherwise. We defined “strong IT lover” as a subject who always chose the10

20% income tax rather than consumption taxes. The strong CT lover and the CT lover evaluate
the tax systems based on the amount of tax burden, because they choose less tax burden. Suchsubjects are only one-third. Most subjects have an irrational choice. One-third subjects choose
consumption tax if the nominal consumption tax rate is identical to the nominal income tax rate(the miscalculation biased). The strong IT lover implies that these subjects prefer income tax toconsumption tax in general. Although subjects seemingly prefer an income tax over a
consumption tax when both taxes are equivalent, the proportion preferring an income tax nearly
equals that preferring a consumption tax if we assume that subjects with a miscalculation bias
prefer a consumption tax when these taxes are equivalent.
Table 6 shows the relationship between subject types and individual characteristics. We use
multinomial logit estimation. The figures show the average marginal effect. Subjects whocorrectly answer the TaxQs are likely to be strong CT lovers or IT lovers. They evaluate tax
systems based on their tax burden, because they can calculate it correctly. If tax burdens areequivalent, their choice depends on their individual preferences concerning taxes. A subject who
prefers consumption tax in the exit survey, who prefer consumption tax if its burden equals thatof an income tax among subjects who cannot correctly answer the TaxQs are likely to be
miscalculation biased. This result supports that they prefer the 20% income tax to the 25% and
22% consumption taxes because they do not understand the definition of a consumption tax. A
subject who prefers consumption tax in the exit survey among subjects who answer the TaxQs
correctly are likely to be the strong CT lovers. They can calculate the tax burden correctly andprefer a consumption tax if amounts owed are equivalent. The table also shows that a subject
who prefers consumption tax in the exit survey is likely to be IT lovers and miscalculationbiased. This result indicates that some subjects who answered the TaxQs correctly did notunderstand the calculation at the time of the experiment but understood it in the TaxQs.

5. Discussion and Conclusion
We examine whether income and consumption taxes are equivalent throughout a choice
experiment. Subjects prefer the 20% income tax to the 25% consumption tax where they areequivalent. This result implies that the equivalence between income tax and consumption tax
does not hold because of the consumption tax miscalculation bias. Subjects calculate the amountof consumption tax in the same way as an income tax calculation, which implies that subjects
mistakenly perceive consumption tax, which has a higher nominal tax rate than income tax, as
having a heavier burden. Consequently, subjects prefer the 20% income tax, which has a lower
nominal tax rate than the 25% consumption tax. Moreover, subjects prefer the 20% income tax
to the 22% consumption taxes, despite the amount of consumption tax being smaller than theamount of income tax. This result also indicates the existence of the consumption tax
11miscalculation bias. Most subjects cannot correctly calculate the amount of consumption tax.
Subjects prefer the 20% consumption tax to the 20% income tax when the nominal tax rate is
identical. Subjects misunderstand that the amount of consumption tax equals the amount ofincome tax because subjects miscalculate the amount of consumption tax. If subjects see that thefinancial burden between the two taxes is equivalent, they prefer consumption tax to income tax.
This result is consistent with that of Blumkin et al. (2012) under the tax rate illusion.
In Blumkin et al.’s (2012) and Chetty et al.’s (2009) studies, the misperception of tax resultsfrom ignoring consumption tax. In particular, the equivalence between consumption and income
taxes is not held by the consumption ignorance bias in Blumkin et al.’s (2012) study. On theother hand, our result implies that consumption and income taxes are not equivalent because
people miscalculate the financial burden of consumption tax even if they can take into accountconsumption tax.
Miscalculation of tax is attributed to an insufficient understanding of tax definitions. Our
result implies that people calculate the amount of consumption tax as if it is tax inclusivedespite it being tax exclusive, so people miscalculate the amount of consumption tax as theyoften do not realize it is already included in the prices. In tax reforms of the future, if all
notations of taxes were standardized as tax inclusive, people could correctly calculate them. As
a result, people could make an unbiased decision. There is a possibility that people miscalculate
the amount of tax even if they consider the existence of tax, so that taxes should be presented by
the notation of being difficult to miscalculate.

References
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Feldman, N. E., and Ruffle, B. J. 2015. The Impact of Including, Adding, and Subtracting a Tax
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Discussion Paper 5022, IZA.
Kachelmeier, S. J., Limberg, S. T., and Schadewald, M. S. 1994. Experimental Evidence ofMarket Reactions to New Consumption Taxes. Contemporary Accounting Research, 10(2),505-545.
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Liebman, J. B., and Zeckhauser, R. J. 2004. Schmeduling. Unpublished.
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Sausgruber, R., and Tyran, J. R. 2005. Testing the Mill Hypothesis of Fiscal Illusion. Public13

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14

Figure 1 Experimental timeline

Figure 2 Screen of the slider task

15

Table 1 After-tax parameters

Income[After-tax income]

Total consumption[After-tax consumption]

1st quintile
2nd quintile
3rd quintile
4th quintile
5th quintile

1600 [1280]
2200 [1760]
2500 [2000]
3100 [2480]
4500 [3600]

1280
1760
2000
2480
3600

1st quintile
2nd quintile
3rd quintile
4th quintile
5th quintile

1600
2200
2500
3100
4500

1600 [1280]
2200 [1760]
2500 [2000]
3100 [2480]
4500 [3600]

1st quintile
2nd quintile
3rd quintile
4th quintile
5th quintile

1600
2200
2500
3100
4500

1600 [1310]
2200 [1800]
2500 [2050]
3100 [2540]
4500 [3690]

1st quintile
2nd quintile
3rd quintile
4th quintile
5th quintile

1600
2200
2500
3100
4500

1600 [1330]
2200 [1830]
2500 [2080]
3100 [2580]
4500 [3750]

Tax system [Tax revenue]
20% income tax [2780]

25% consumption tax [2780]

22% consumption tax [2510]

20% consumption tax [2320]

16

Table 2 Summary statistics of individual characteristics and computational abilities

Age
FemaleUndergrad
Economics major
Social science major (excl. economics)
Engineering major
Natural science major
Other major
CRT all correct
TaxQ1 (income tax) correct
TaxQ2 (consumption tax) correct
TaxQ all correct
Subject who prefers income tax in the exit survey
Subject who prefers consumption tax in the exit survey
Observations

Random22.57(1.76)
0.38(0.49)
0.62(0.49)
0.04(0.04)
0.23(0.42)
0.40(0.49)
0.06(0.23)
0.28(0.41)
0.36(0.48)
0.98(0.14)
0.17(0.38)
0.17(0.38)
0.32(0.47)
0.51(0.50)
53

Real-effort Difference
1.24***
21.33(1.62)(0.33)-0.01
0.38(0.49)(0.10)-0.19**
0.81(0.40)(0.09)-0.02
0.06(0.24)(0.04)
0.09
0.13(0.08)(0.34)-0.07
0.46(0.10)(0.50)
0.15-0.10(0.36)(0.06)
0.19
0.09(0.08)(0.40)
0.38-0.03(0.49)(0.10)
1.00-0.02(0.02)(0.00)
0.29-0.12(0.46)(0.08)
0.29-0.12(0.08)(0.46)
0.38-0.06(0.49)(0.10)
0.42
0.09(0.08)(0.50)
52

Note: “Other major” includes foreign language, health, and humanity majors.

17

Table 3 Effects of experimental conditions on preferences for income and consumption taxes

After
Slider task
Slider task × After
Constant
Constant = 0.5
Constant + After = 0.5
Constant + Slider task = 0.5
Constant + Slider task + After = 0.5
Observations
Clusters
R2

IT (20%) or CT (25%)
(1)
0.038
(0.060)-0.137*(0.078)0.078(0.080)0.868***(0.047)F(1, 104) = 61.10(p=0.00)
F(1, 104) = 99.66(p=0.00)
F(1, 104) = 13.74(p=0.00)
F(1, 104) = 9.62
(p=0.00)
210
105
0.031

IT (20%) or CT (22%)
(2)
0.075
(0.065)-0.082(0.092)-0.037(0.094)0.717***(0.063)F(1, 104) = 12.00(p=0.00)
F(1, 104) = 26.91(p=0.00)
F(1, 104) = 3.97
(p=0.05)
F(1, 104) = 5.00
(p=0.03)
210
105
0.017

IT (20%) or CT (20%)(3)-0.019(0.057)-0.031(0.096)-0.000(0.091)0.396***(0.068)F(1, 104) = 2.33
(p=0.13)F(1, 104) = 3.31
(p=0.07)
F(1, 104) = 3.97
(p=0.05)
F(1, 104) = 3.00
(p=0.09)
210
105
0.001

Notes: Dependent variable = 1 if a subject chooses an income tax (IT). Dependent variable = 0
if a subject chooses a consumption tax (CT). Standard errors clustered by subject reported inparentheses.
*** Significant at 1%; ** significant at 5%; * significant at 10%.

18

Table 4 Effects of experimental conditions and computational abilities
Dependent variable:

Income tax (1) or consumption tax (0)
(1)
(2)
(3)
Constant (Baseline: CT25) 0.868***
2.015***
1.989***(0.047)(0.515)(0.492)CT22-0.151***-0.151***-0.132**(0.057)(0.057)(0.062)CT20-0.472***-0.472***-0.449***(0.070)(0.070)(0.078)
After
0.038
0.038
0.038
(0.060)(0.061)(0.061)After × CT22
0.038
0.038
0.038
(0.071)(0.072)(0.072)After × CT20
-0.057-0.057-0.057(0.069)(0.069)(0.069)Slider task
-0.137*-0.161*-0.150*(0.078)(0.082)(0.077)
Slider task × CT22
0.055
0.055
0.080
(0.093)(0.094)(0.096)
Slider task × CT20
0.106
0.106
0.119
(0.105)(0.105)(0.107)
Slider task × After
0.078
0.078
0.078
(0.080)(0.081)(0.081)After × Slider task × CT22-0.115-0.115-0.115(0.105)(0.106)(0.106)After × Slider task × CT20
-0.078-0.078-0.078(0.111)(0.112)(0.112)
CRT all correct
0.097*(0.056)
CRT all correct × CT220.054
(0.060)
CRT all correct × CT20
-0.013(0.095)TaxQ all correct-0.125(0.084)TaxQ all correct × CT22
-0.224**(0.086)TaxQ all correct × CT20
-0.107(0.105)
Individual controls
No
Yes
Yes
Observations
630
630
630
Clusters
105
105
105
2
0.178
0.218
0.265
R

Notes: CT25 is the 25% consumption tax. CT22 is the 22% consumption tax. CT20 is the 20%
consumption tax. Standard errors clustered by subject reported in parenthesis.
*** Significant at 1%; ** significant at 5%; * significant at 10%.
19

Table 5 Subject type
Strong CT lover
Income (Random)
Before
After

11.3%
9.4%

Income (Real-effort)
Before
After

17.3%
15.4%

IT loverMiscalculation biased

Strong IT lover

13.2%
11.3%

34.0%
41.5%

35.8%
37.7%

5.7%
0.0%

15.4%
17.3%

25.0%
32.7%

28.8%
34.6%

13.5%
0.0%

Others

Notes: Strong CT lover is a subject who always chooses consumption taxes rather thanincome tax. IT lover is a subject who chooses income tax only when the tax burdens areequivalent and choses consumption taxes 22% and 20% otherwise. Miscalculation biased is asubject who chooses the 20% consumption tax when the nominal tax rates are equivalent andincome tax otherwise. Strong IT lover is a subject who always chooses the 20% income tax
rather than consumption taxes.
Table 6 Effect of computational abilities and direct tax preference on subject typeTaxQ all correct
Prefer IT in the exit survey
Prefer CT in the exit survey
Prefer IT × TaxQ all correct
Prefer CT × TaxQ all correct

Strong CT lover(1)0.350***(0.124)0.074(0.087)0.086(0.076)-0.280*(0.145)0.290*(0.166)

IT lover(2)0.250**(0.099)-0.036(0.092)0.025(0.077)-0.069(0.129)0.515***(0.169)Miscalculation biased(3)-0.115(0.231)
0.083(0.117)0.268***(0.105)0.272(0.268)1.744***(0.304)

Strong IT lover
(4)
0.045
(0.185)-0.073(0.094)-0.238***(0.091)0.028(0.219)-3.415***(0.317)

Notes: Experimental conditions and individual characteristics are also controlled. Figures report
average marginal effects. Standard errors are calculated by delta-method.
*** Significant at 1%; ** significant at 5%; * significant at 10%.

20

Appendix: Instructions (translated from Japanese)
Experimental Contents
In this experiment, you choose a “tax system” in a hypothetical world. The “tax” in thisexperiment is not the real tax that is imposed on payment but a hypothetical tax.
First, your “income” is determined by a method (as described herein). The “income” is assigned
to five income ranks (1600, 2200, 2500, 3100, and 4500 points). In responding to an “income,”
the amount of “consumption” is automatically determined. The set of “income” and“consumption” is as below:
Income (points)

1600

2200

2500

3100

4500

Consumption (points)

1600

2200

2500

3100

4500

However, a “tax” is imposed on this “income” and “consumption.” The effective “tax” depends
on your choice (as described herein). A “tax” is of two types. The example tax rate is just an
example and may be different from the experimental tax rate. The taxed point under 10 points isrounded off.
1. Income tax
An income tax is a tax in proportion to income. For example, if the income tax rate is 10%, yourincome reduces by 10%. Your consumption also reduces the same proportion in responding to
your income. In other words, if the income tax rate is 10%, the consumption is also reduced by
10%.
2. Consumption tax
A consumption tax is a tax in proportion to consumptions, and the tax-inclusive amount ofconsumption does not change even if the consumption tax is imposed; the net (substantial)
consumption is found by subtracting the amount of taxation from consumption in responding to
the income.
We converted the after-tax total consumption into your payment (1 point = ¥1).
“Income” determination for Random group [Real-effort group]

The “income” is randomly assigned to five income ranks (each 20% probability) by a computer.
21

The number of subjects is evenly assigned to the five income ranks.
[The “income” is determined on the basis of your performance of a “slider task.” We explain
later the slider task and your income in detail.]Effective “tax system” determination

In this experiment, each person chooses a tax between two options multiple times before andafter your income is determined. One tax choice for each person is randomly selected and thetax is imposed on your payment

Experimental Procedure
This experiment is conducted using a computer. Please follow the directions of the computer.
Mind the time restriction.
1. “Tax” choice (before your income is determined)
You choose a tax between two options. After choosing one option, you press the OK button. The
time restriction is 120 seconds. The tax choice is conducted multiple times.
2. Income determination
Your income is determined randomly [on the basis of your performance of a task]. Pleaseconfirm your income displayed in front of you.
3. “Tax” choice (after your income is determined)
You choose a tax between two options. After choosing one option, you press the OK button. The
time restriction is 60 seconds. The tax choice is conducted multiple times.
4. Calculation of after-tax income and consumption
First, one tax choice for each person is randomly selected and the tax is imposed on yourpayment. Please confirm after-tax income and consumption.
After checking your payment, please answer a survey.

22

Explanation of a Slider Task
In this task, there are 48 sliders on your screen, as in the below figure. By using the mouse, you
adjust the slider to the position at 50 as much as possible. The time restriction is 120 seconds.
Each slider is positioned at 0 at the first time and you can move each slider to 100. Each valueof the slider is displayed at the right of each slider. By using the mouse, you adjust the sliders.
You can adjust the position of each slider as many times as you want. Your point in this task is
the number of the slider positioned at 50 at the end of the task.
You practice the slider task twice before you move on to the main part of the task.
Income determination
Your income is determined on the basis of your relative performance of a slider task. The betteryou perform, the more income you can get. The number of subjects is evenly assigned to thefive income ranks. For example, if the number of participants is 20, 4 people are assigned toeach income rank.
Experimental procedure
1. Practice task (120 seconds × 2)
You practice the slider task twice. This task does not determine your income rank.
2. Forecasting income rank task
You forecast your income rank on the main part of the slider task before moving on to the mainpart. Please choose an income rank that likely to be assigned.
3. Main task (120 seconds)
You try the main part of the slider task. The time restriction is 120 seconds.
4. Result summary
Please confirm your income.

23

Figure Screen of the slider task

24