Yesterday’s edition of the Junior Scholars Workshop at Conglomerate featured Brian Galle and Kirk Stark (with a touch of Vic Fleischer thrown in for good measure) discussing Cognitive Bias and § 164:

Brian Galle (Graduate Tax Fellow, Georgetown) has posted his paper, A Republic of the Mind: Cognitive Biases, Fiscal Federalism, and Section 164 of the Tax Code, on SSRN.  Here is the abstract:

Our federal government annually passes up more than $75 billion in potential revenue in an effort to guide that money to the States under § 164, the provision allowing itemizing taxpayers to deduct the cost of the state and local income, property, and sales taxes they paid during the tax year. The eye-popping size of that number makes § 164 a perennial issue in tax policy circles, and, as one of the deductions omitted from the Alternative Minimum Tax’s parallel tax universe, the section is also a key component of debates about the AMT. Recent Bush administration rumblings that the deduction may be on their agenda for reform, even aside from any possible AMT fix, make a reconsideration of § 164 especially timely.

It has been almost a decade since the last major legal academic examination of the merits of the deduction. This Article aims, humbly, at attempting to update that earlier work with recent developments, such as our expanded understanding of the limits of taxpayers’ capacity to analyze their own economic situation, and the need for more cooperative tax enforcement in a “flatter” world. It also attempts to address the as-yet unconsidered problem of how to view the “horizontal equity,” or fairness, of state taxation in light of the fact that states both must expend money to comply with federal mandates and also receive direct grants of money from the federal government.

More generally, however, my goal here is to show that § 164 is about more than (boatloads of) money. Other commentators, especially economists, have recognized that the deduction may slightly shift the locus of regulation from federal to state and local governments. In this Article I argue that the deduction may play a large but currently underappreciated role not only in the relative sizes of local and federal governments but also in the structure and effectiveness of sub-national governments. Local governments develop in response both to direct political demands and also the indirect pressure generated by the threat of “exit,” or out-migration to a more efficient or more responsive jurisdiction. The deduction, I argue, significantly affects both of these factors — most obviously by reducing exit pressures, but also by in more subtle ways transforming the processes of direct politics.

Thus, what we should think about § 164 depends on much more than the bottom of a balance sheet. Any fully considered judgment must include our philosophy of mind, our plan for the individual states’ place in an international marketplace, and our optimal design for good local government. Seventy-five billion? That’s nothin’.

Kirk Stark (UCLA) offers detailed commentary on Brian’s paper, concluding:

Galle’s suggestion that some sort of alternative approach is preferable (he alludes to his preference for a “Rawlsian” approach, but does not elaborate) is a challenge to the very idea of “consumer sovereignty.” Perhaps consumer sovereignty deserves to be challenged in the context of the market for state/local public goods and services. Galles has taken the important first step of offering some suggestions for why that might be the case. As other readers will surely note, I have only scratched the surface of Galle’s ambitious paper. There is much here to comment on, and I hope that other readers will take the opportunity offered by the good folks at Conglomerate to post their views on the Galle paper. I enjoyed having the opportunity to read and comment on this paper, and I look forward to comments from others.

Vic Fleischer (UCLA) chimes in as well, commenting in part:

One of Brian’s accomplishments with this paper is showing us how little we know. We know that cognitive bias can affect market decisions, but we have not quite sorted out its effect on the arguments that assume rational market actors. Brian’s paper is a good step in the right direction.