Tax Salience and Consumer Behavior

Standard models of economic behavior have long held that individual consumers will make their purchasing decisions in a well-informed and rational manner. Challenging that assumption, Drexel LeBow assistant professor of economics Sebastien Bradley, PhD looked to evidence from experiments at the intersection of psychology and economics — known as behavioral economics. Those experiments suggest that individuals may be susceptible to biases that lead them to make choices that depart from the assumptions made by standard models.

Based on existing research, Bradley knew that tax transparency can affect consumer behavior. For example, in one study consumers reduced their purchases of health and beauty products when sales taxes were included directly in prices posted on grocery store shelves as opposed to having them added at the register. For his own research, Bradley’s goal was to test how taxation and pricing correlate for much larger purchases, such as homes. To do this, he examined the relationship between a special feature of the Michigan property tax system and home prices in that state.

In Michigan, homebuyers may face significantly lower tax bills in the year they purchase their homes than they will beginning on January 1 of the next year. Logically, this should make homebuyers willing to pay an amount equal to the discount they’ll receive in that first year. However, Bradley found that prices are raised by roughly 30 times the amount of the temporary property tax reduction, which would be logical if these lower tax obligations would persist for the lifetime of the home.

The buyers’ illogical behavior is likely a result of confusion. Sales listings and mortgage lenders’ good faith estimates of homeownership costs explicitly emphasize sellers’ current tax obligations, while the only party to the real estate transaction with a financial incentive to be attentive to predictable future tax increases are the buyers themselves. Bradley’s findings illustrate that the discrepancy in pricing is unlikely to be eradicated until further efforts are made to draw consumers’ attention to a relatively invisible feature of the property tax system.

To support his conclusion, Bradley found that a voluntary disclosure by a single real estate broker in Michigan is associated with an important reduction in how much homebuyers overpay for homes featuring these temporary tax discounts. Better, more transparent, property tax information may be the key to remedying consumers’ inattentive behavior.

Sebastien Bradley’s paper “Inattention to Deferred Increases in Tax Bases: How Michigan Homebuyers are Paying for Assessment Limits” was published in the Review of Economics and Statistics