Although taxes may not be front of mind for many of us, they quietly shape nearly every aspect of the economy — and our lives.
“Generally, we think about having taxes for three reasons,” says Rebecca Lester, associate professor of accounting and one of three inaugural Botha-Chan Faculty Scholars at Stanford Graduate School of Business. “One is because we need money to run the government… [two] is typically for redistribution… and the third reason is to change behavior, to change behavior of individual taxpayers or business taxpayers.”
Whether it’s a cigarette tax meant to curb smoking or an R&D tax incentive designed to spur innovation, taxes provide incentives — or disincentives — that aim to nudge us in one direction or another. And when those incentives change, behavior often follows.
One of Lester’s current research efforts has focused on the impact of a recent shift in domestic tax policy: a provision in the 2017 Tax Cuts and Jobs Act that removed an important R&D deduction, forcing companies to instead spread out those expenses over time.
“We identified over 600 companies that disclosed in the very first year alone that they were impacted… Beyond their tax bills going up by a huge amount — by about 60% — we found that these companies actually cut R&D in that first year. So even when there was still some hope that Congress might fix it, some companies were so hurt by this provision that they cut their R&D by billions of dollars in aggregate,” Lester says.
The impact of tax policy doesn’t stop at the corporate level.
Governments use taxation to shape personal choices, too, offering credits for electric vehicles or imposing taxes on things like soda. So what actually moves people to act?
“There’s lots of incentives at the federal level, at the state level, at the local level, and at some point it’s kind of, do we need them all?” Lester asks. “What’s really the one that motivates or changes behavior?”
This episode also features Katie Cantrell, of Greener by Default.
If/Then is a podcast from Stanford Graduate School of Business that examines research findings that can help us navigate the complex issues we face in business, leadership, and society. Each episode features an interview with a Stanford GSB faculty member.
Full Transcript
Note: This transcript was generated by an automated system and has been lightly edited for clarity. It may contain errors or omissions.
Coffee Shop Customer: I just want a couple of lattes. What kind of milk do you have?
Kevin Cool: How do you change someone’s behavior without trying to persuade them?
Katie Cantrell: If you go into your average coffee shop and order a latte, it’s just assumed that you want dairy milk unless you specially request a plant-based milk.
Barista: We usually double check, but like a default latte is cow’s milk.
Katie Cantrell: We work to flip the default and just post signs saying our drinks are made with oat milk by default, let us know if you’d prefer dairy, soy, or almond milk.
Coffee Shop Customer: Can I have one oat milk latte and one house made macadamia one?
Barista: Yeah.
Kevin Cool: Katie Cantrell runs a nonprofit called Greener by Default, which helps businesses and other organizations bring about climate friendly actions.
Katie Cantrell: We actually implemented this at LinkedIn’s coffee bar in their San Francisco office, and they cut dairy milk from 70% to 18% of milk served, which reduced the carbon footprint from dairy by 50%.
Kevin Cool: This method is called choice architecture. And from the coffee shop to the halls of Congress, it can have a powerful impact on the decisions we make.
Katie Cantrell: You know we like to think that we make these very reasoned, logical decisions based on our beliefs, but oftentimes what happens is we make our decisions about our behavior based on what’s easy, what we’re familiar with, what people around us are doing, what’s visible to us.
Kevin Cool: Another example, when people are RSVP to conferences or weddings and attendees must check a box to request a vegetarian meal. Greener by Default tries to turn that around. At Harvard University and UCLA, they worked with professors who were advocating for climate-friendly dining changes at campus events.
Katie Cantrell: About 20% of students are vegetarian or vegan, so they will request a plant-based option. But what these professors did is they looked at what happens if plant-based is a default and people can check a box to request a meat meal, and what they found was about a third of people did request meat, but two thirds of people stuck with the plant-based default. So that’s a nearly 50 percentage point increase in the number of people choosing a plant-based meal simply by changing a couple of sentences on the registration form.
Kevin Cool: Katie believes attendees might have complained if all the meals were vegetarian. This way everyone gets to choose what they’d like to eat. Governments, too, try to shape behavior sometimes in ways that aren’t so obvious, like the tax code. How that works, from the behaviors and incentives or disincentives at play, to the effectiveness of the policy, is something worth exploring, according to Becky Lester, a tax expert and associate professor of accounting at Stanford Graduate School of Business,
Rebecca Lester: I think a lot of policymakers are really interested in encouraging green investment, encouraging people to buy electric cars. But what I don’t think we have great evidence on is what exactly motivates them to do it? Is it a federal tax credit? Is it some type of local benefit that you get? Is it just the warm glow feel that you’re doing something better for the environment?
Kevin Cool: Understanding what motivates our decisions can inform the policy choices we make, and that’s our focus today how tax policy impacts our behavior.
This is If/Then a podcast from Stanford Graduate School of Business, where we examine research findings that can help us navigate the complex issues facing us in business, leadership and society. I’m Kevin Cool, senior editor at Stanford GSB.
Kevin Cool: You study taxation and you’ve done several interesting papers recently about taxes and their effects and their implications. I want to start today though by scoping out a little bit and just talking about taxes broadly, like why do we have taxes?
Rebecca Lester: So generally we think about having taxes for three reasons. One is because we need money to run the government, so taxes are a natural source or are the source of revenue for the government.
The second one is typically for redistribution. So if you think about any type of political administration that’s in office, they may have their own views on redistribution, but taxes are a way to redistribute wealth in the economy.
And the third reason is to change behavior, to change behavior of individual taxpayers or business taxpayers, either by motivating things that we want, like we want them to spend more money on investment or to discourage certain activities that we don’t want them to do, for example, like smoking by individuals or environmental dumping of pollutants.
Kevin Cool: So you would apply a tax on cigarettes, for example, as a disincentive to get people to stop smoking?
Rebecca Lester: That’s right, exactly. So policymakers will use the tax code as a way to encourage certain behaviors or in the case of smoking, discourage other types of behaviors that they don’t want.
Kevin Cool: So let’s get into some of that specifically around innovation. You did a study that looked at a tax provision that had been changed, that had originally allowed companies to deduct expenses related to research and development. Talk a little bit about that study.
Rebecca Lester: Sure. Yeah. This has been a really fun study to work on over the past year or so. There’s kind of these two dials that, at least in the U.S., come through the tax code and motivate innovation. One is kind of this extra credit that we give for R&D, and the second is just the base level allowing a company to deduct the expenses they incur.
So let’s say you’re a pharmaceutical company and you pay your scientists who are involved in R&D, or let’s say you’re a tech company and you pay your programmers to help develop the next great app or the next piece of code. Their salaries would be considered to the extent they’re used in R&D, actually R&D expense, and the government typically would allow you to deduct those immediately as R&D deductions.
Unfortunately, in the 2017 Tax Act, which changed a lot of different provisions for businesses, it was an expensive act, and so one of the ways that Congress tried to pay for that act was to remove actually this deduction for R&D expenses.
And so when it was put into the act, the implementation date was actually deferred, they said, we’re going to put this in to kind of make the math work, but we’re going to kick the start date to 2022 under the idea that Congress will just fix it
Kevin Cool: And what was the outcome?
Rebecca Lester: So unfortunately, Congress never got around to changing it. At this point, we have this huge disincentive for R&D because you can’t take these deductions immediately, they have to be spread out over time, and by doing that, it effectively reduces today’s benefit. So what my coauthors and I did was actually figure out how many companies are impacted by this. We combed through hundreds of financial statements of public companies because those are the companies we can see. We identified over 600 companies that disclosed in the very first year alone that they were impacted. And then we studied, well, what did these companies do? So beyond their tax bills going up by a huge amount by about 60%, we found that these companies actually cut R&D in that first year alone. So even when there was still some hope that Congress might fix it, we saw that some companies were so hurt by this provision that they cut their R&D by billions of dollars in aggregate, and we’re already starting to see this effect really of R&D going down primarily because we took away this tax incentive.
Kevin Cool: And presumably there are downstream effects of that too that we don’t even know yet.
Rebecca Lester: Absolutely. So we focused on the 2022 year because that’s what we have data for, but as this law stays in place, we expect those effects to get even bigger. And I actually think that some of the biggest effects might be amongst small or medium sized companies who didn’t have a lot of extra cash reserves to pay the big tax hit that happened in that first year. I think in those companies, we could actually see people getting laid off. Unfortunately, we don’t have data right now to look at that, but it’s a really important area that I think would document some even bigger potential effects than what we found in that first year alone.
Kevin Cool: And you noted that, internationally, countries have much more generous tax policies. Did your studies show a difference for corporations that have overseas subsidiaries or invest overseas?
Rebecca Lester: Yeah, exactly. What we find is actually the biggest impacts are among kind of two companies. So one are just the companies that naturally have more R&D, tech firms doing a lot of R&D or even the pharma companies. Those are definitely the ones the most impacted. The other group of companies that we see are really hurt are what I’ll call domestic only companies. So companies that don’t have international operations that might be able to benefit from some of these more favorable regimes offshore. If you’re a fully domestic only company, you don’t have the ability to do your R&D someplace else. And so those companies also seem to be the ones that are trimming their R&D pretty quickly right away in this first year.
Kevin Cool: And once again, from a competitive standpoint, it hurts the overall US economy, I would think if people now are offshoring essentially R&D, right?
Rebecca Lester: That’s right. If we think about places like China that have a super deduction for R&D or frankly in Europe, which has a lot of regimes called innovation box regimes or patent box regimes, these are pure tax policies that provide very low tax rates on income earned from R&D.
Kevin Cool: Innovation boxes.
Rebecca Lester: Yes.
Kevin Cool: What are those and why are they important?
Rebecca Lester: The idea under underlying innovation boxes is tax competition. It’s tax competition frankly in an international realm. It’s the idea that one of the ways that countries can compete for economic activity, one of the ways countries can compete for businesses, is by offering favorable tax policies. And one of the types of activities that governments really want to attract is innovative activity that often bring high wage jobs and have really positive economic spillovers.
The problem is that the types of activity that bring those jobs and really good economic spillovers are often attached to things like intangibles, intangible assets that we can’t see. What’s an example of that? We could think about a patent for a drug. You could think about the intellectual property that goes into computer software code. And those things certainly require typically high income wage earners to work on them, but because they’re intangible, they’re actually relatively easier to move around the world to a place that has lower taxes.
So the idea with an innovation box or a patent box is for countries that have higher rates, places like the U.K., places like France to say, well, we actually want companies to keep those assets in our country and the income, we want them to report the income in this country too. And so if we do that, then let’s just provide a lower rate that’s earned on that income. So in short an innovation box or patent box is a way for a company to say, well, we’re going to call all of our income innovation or patent related or some portion of our income, and if we check that box or put the income inside that box on the tax return, it’ll get subject to a lower tax rate.
Kevin Cool: So the box literally refers to something on the tax form. That’s why it’s called box?
Rebecca Lester: Exactly. There’s a box that’s checked or some box about the amount of income that would qualify for this lower tax rate.
Kevin Cool: To what extent are tax policies a tool in trade competition?
Rebecca Lester: They’ve been used quite a bit in trade competition, and you could think about two different ways that they’re used. So one is certainly through tariffs. Tariffs is a type of tax or customs duties.
Kevin Cool: We’ve heard a lot about tariffs recently.
Rebecca Lester: We’ve heard a lot about tariffs. And so certainly one way to directly affect trade is to increase or decrease the tariffs or taxes on imports and exports, especially if you want to change the dynamics with a particular trading partner, like for example, China with the tariffs that President Trump imposed in his first administration. So tariffs are one form of tax policy to change trade patterns.
The other way is basically through certain types of incentives that motivate domestic activity with the idea that if we actually motivate or incentivize domestic activity through the tax code, it effectively encourages purchase of domestic goods or hiring of domestic labor. Actually, a really great example of this are a lot of the provisions in the Inflation Reduction Act. And what’s very interesting about many of these provisions is that they require that a lot of the input parts or even the labor are domestically sourced. A great example is that many of the provisions provide some type of tax credit. That tax credit will be five times larger if you meet certain domestic wage or apprenticeship requirements. With this idea that not only did the Biden Administration really want to motivate investment in green technologies, but they want to do it by putting U.S. citizens, American workers, to work. And so there’s a lot of examples of this in the tax code over time.
Kevin Cool: So let’s stick with the Inflation Reduction Act just for a moment.
Rebecca Lester: Sure.
Kevin Cool: Do we have any evidence yet that it’s working?
Rebecca Lester: Not really. The evidence is quite early because of the fact that a lot of the credits or even some of the trading provisions are just getting kind of rolled out now. What we’re seeing is a lot of interest. I think we’re seeing a lot of companies claiming the credits, but the question ultimately is, is this motivating activity that would’ve occurred otherwise or is this actually motivating new investment in green technologies?
A lot of people think it really will because it was a lot of money that went into this, so a lot of money was allocated for these credits. We observe companies claiming them and trying to parse out would they have done this otherwise is hard to know, but given the amount of the benefit, I expect there probably will be some really positive green technology environmental investment benefits to it.
Kevin Cool: So taxes also can be an incentive for individuals. There are some provisions that are essentially incentives, for example, to put solar panels on your home and so on. Do we know whether that’s going to work?
Rebecca Lester: What we have seen in the past is that these types of green incentives, they have some effect on encouraging people to buy, for example, hybrid cars or electric cars, that there is evidence that those types of incentives do motivate or change some taxpayer behavior. I think the big question that we have here, or the big question that I have is there’s lots of incentives at the federal level, at the state level, at the local level, and at some point it’s kind of do we need them all? What is really the one that motivates or changes behavior?
So I think a lot of policy makers are really interested in encouraging green investment, encouraging people to buy electric cars, but what I don’t think we have great evidence on is what exactly motivates them to do it? Is it a federal tax credit? Is it some type of local benefit that you get? Is it just the warm glow, feel that you’re doing something better for the environment? Probably a little bit of all of this, but I think those are really interesting questions that we still need some more answers to.
Kevin Cool: We’ve also seen, and this has always been the case, but more recently, I think we’ve seen the more pronounced effects of tax policies incentivizing companies to say, move their headquarters from one state to another. Talk a little bit about how that works, what the thinking is, and whether that is a net gain for the U.S. economy, or is it just a net gain for that state?
Rebecca Lester: So just like countries compete by using tax policy, so do state and local governments. So it’s also a really interesting landscape to observe a lot of this tax competition. And there’s a couple of different ways that states and localities can compete. One might be just with the tax rate. So if we set a lower rate or if a state sets a lower rate, that alone might attract individuals. Think about Florida, they have no personal income tax, so we see a lot of retirees in Florida because they don’t pay tax there. The same goes for companies: you could think about companies thinking about where to locate, again, tax shouldn’t be the number one driver of that decision, but what we know from the research is that it does have a role. And so on average we observe more companies locating in places that have lower taxes, holding everything else constant.
Now, other than just setting tax rates that apply to everyone, state and local governments will use tax incentives to try to attract certain types of companies to their state or locality or also retain those companies.
We see this much more here in the U.S. versus in places like Europe. In Europe, actually, a lot of this is prohibited. It’s considered what they call illegal state aid, that you’re not allowed to use one-off incentives or certain types of firm specific benefits to try to compete with your neighbor. But in the U.S. it’s under a federal system, this is very much allowed, where state and local governments can use firm specific tax incentives to try to attract certain types of industries to the state or even keep them there. And so we’ve seen this activity really ramp up a lot over the last 20, 25 years, where states will use anything from income tax credits to try to attract a company to a state, to other types of tax incentives.
Things like sales and use tax abatements, property tax, abatements, all the way to cash grants. So if we just give, for example, some states, we’ll call it a closing grant, which is basically a cash payment to the company that might allow them to move. One of the best examples of this was Amazon when they were searching for their second headquarters, they launched a very public search in which they actually said, we’re looking for second headquarters. We want everyone to bid. And then you could actually observe all the state and localities that were bidding on—
Kevin Cool: It was almost like a sweepstakes.
Rebecca Lester: And you could see state and local governments, the ones who really wanted Amazon, were going to so many steps to try to get them there, not just providing really large packages of tax incentives. I think there was one city or state that may have changed their name or was willing to change their name in order to attract Amazon because the idea is that by bringing a company in like that, you’re going to increase jobs, which of course, presumption is it’s viewed quite favorably in the local market.
Kevin Cool: And certainly politically these are wins for governors or state representatives or whomever.
Rebecca Lester: That’s right.
Kevin Cool: Do we know whether the actual benefits accrue to those places? Certainly jobs is one, expanding the tax base locally, all of those things, or are they mostly, or primarily optics?
Rebecca Lester: This is the big debate. So the big debate is to what extent are these overall revenue increasing for a state versus what one side would call kind of corporate welfare that we’re just giving taxpayer money away to companies.
The evidence that we have is that these large package of incentives is indeed kind of associated or causes greater job growth. Now, that makes a lot of sense to me because a lot of these really large packages, we’ll call them mega deals, are often granted to attract a company to move to a state. And so observing larger job growth afterwards seems to make kind of sense with if we give a lot of money and the company moves, then that company specifically is going to hire more workers. But I think we have a lot of questions after that that frankly are quite open. Where do those workers come from? In a tight labor market, are those new workers who are entering the labor force and now joining this new company, or are they workers that are coming or stolen from another firm and incumbent company in the same place?
Kevin Cool: And it seems to me some of this very quickly crosses over into a political realm. I’m thinking about for example, in a state like California where there were big incentives to purchase electric vehicles that didn’t exist in some other states. And, you know, if a particularly activist legislature wanted to get into what you eat in addition to what you drive or maybe what you don’t eat. I mean, we did it with smoking obviously,
Rebecca Lester: And I think this is at the heart of a lot of tax policy debates, which is what is the most efficient tax system that we could have? So you could think about two extremes, which is just one extreme, which is only tax rates with no special carve out. So let’s just have an overall low tax rate that should motivate people to hopefully make the right decisions, motivate companies to invest and employ workers in the U.S. versus a tax system that maybe has a bit of a higher rate, but then provides some type of either targeted incentives or very clear disincentives through the tax code. And we’re kind of at the place where we have tax rates that are kind of middle to high with a lot of incentives, but the incentives and the disincentives are so complicated it’s hard for any one person to really navigate it.
But you could also imagine when does it go too far? When do we start actually taxing certain types of behavior that normally we would just expect individuals to uphold under the social contract?
I think it’s a great question, but I think that that lies at the heart of a lot of the tax policy debates that we have.
An example is the soda tax that’s many cities have passed, which is saying, okay, we think there’s some kind of negative effect of people drinking too much soda just like with cigarettes, and so let’s pass a soda tax or let’s pass a plastic bag tax, taxes are often what people shift to change behavior in some way, and I think it’s a question we should all be asking ourselves. At what point is too far? What is too much?
Kevin Cool: Becky, you have a fifth grader at home.
Rebecca Lester: Yes.
Kevin Cool: You’re very passionate about taxation and the research that you do. How do you explain taxes to a fifth grader?
Rebecca Lester: The most effective way I found is by imposing a Mom Tax.
Kevin Cool: A Mom Tax?
Rebecca Lester: A Mom Tax. So last weekend we made cookies at home, and so the Mom Tax was to basically take a couple of those cookies for myself.
Kevin Cool: And she understands that connection.
Rebecca Lester: She understands the fact that she doesn’t get a hundred percent of whatever she produced and that some of it’s going to some other body that helped her produce that activity in some way
Kevin Cool: And get used to it
Rebecca Lester: And get used to it. This is a very small tax relative to the bigger taxes that she’ll likely pay in her lifetime.
Kevin Cool: Oh, that’s great. I have to say, I don’t think I have ever required a Dad Tax. This opens up a whole new area of parenting.
Rebecca Lester: There you go, there you go.
Kevin Cool: From the kitchen table to the corporate headquarters, understanding what motivates our decisions is key to getting the outcomes we want.
If/Then is a podcast from Stanford Graduate School of Business, I’m your host, Kevin Cool. Our show is written and produced by Making Room and the Content and Design team at the GSB. Our managing producers are Michael McDowell and Elizabeth Wyleczuk-Stern. Executive producers are Sorel Husbands Denholtz and Jim Colgan. Sound design and additional production support by Mumble Media and Aech Ashe.
Special thanks to Katie Cantrell.
For more on our faculty and their research, find Stanford GSB online at gsb.stanford.edu or on social media @stanfordgsb. If you enjoyed today’s conversation, consider sharing it with a friend or colleague and remember to subscribe to If/Then wherever you get your podcasts, or leave us a review. It really helps other listeners find the show.
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Producer: Which one did you get me?
Coffee Shop Customer: Uh, the macadamia.
Producer: Oh, nice.
Coffee Shop Customer: I initially wanted it for myself, but…
Producer: Did you try it?
Coffee Shop Customer: I want to try it.
Producer: Try it.
Coffee Shop Customer: Oh yeah. Very nice.
Producer: Good. Cheers, take care.
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