Mental accounting & tax 2
"The trick is to stop thinking of it as 'your' money": Mental accounting and taxpaying
Julie S. Ashbya and Paul Webleya,b
aSchool of Psychology, University of Exeter
bSchool of Oriental and African Studies, University of London
Running Head: Mental accounting & tax
Key words: mental accounting, taxpaying, occupational group
Abstract
Twenty years ago, Shefrin and Thaler (1988) introduced the concept of mental accounting — the idea that people have a number of different mental accounts and they try not to tap into resources that exist in separate mental accounts. To date, this concept has been most commonly applied to the personal finance literature, and it is only relatively recently that it has been used in the context of taxpaying (Adams & Webley, 2001; Ashby & Webley, 2008). Exploring the existence of different mental accounts in a taxation context is important because how people think about money could influence their behaviour towards it (Adams & Webley, 2001). To this end, this paper draws on data from a qualitative interview study in Australia and a focus group study in the UK. The findings confirm that the concept of mental accounting is relevant to taxpaying in both countries, with some taxpayers placing sources of extra income (such as tips) into a mental account earmarked as theirs to spend as they wish (not to be declared to the tax office). Moreover, through comparing two different occupational groups, the findings indicate that the mental account extra income is placed in is tied to occupational group membership. Implications for authorities and directions for future research are discussed.
"The trick is to stop thinking of it as 'your' money": Mental accounting and taxpaying
Coined by Thaler (1980) and colleagues (Shefrin and Thaler, 1988), the term “mental accounting” can be defined as “a set of cognitive operations used by individuals and households to organize, evaluate, and keep track of financial activities” (Thaler, 1999, p.183). One aspect of mental accounting is categorization or labeling. According to Thaler (1999) money is labeled at three levels: expenditures are grouped into budgets (e.g., food, travel, household bills etc.); wealth is allocated into accounts (e.g., current, savings, pension, “petty cash”); and income is divided into categories (e.g., regular, windfall). In economics, it is assumed that money is fungible, that is, money in one account is a perfect substitute for money in another, or regular income is functionally equivalent to windfall income. However, research studies (e.g., Burgoyne, 1995; Heath & Soll, 1996) and everyday anecdotes suggest that this is not the case.
For example, imagine that you are going to see a play. As you enter the theatre you realise that you have lost your pre-purchased ticket, and have to pay another £25 if you want to see the play. What do you do? If you do decide to buy another ticket you are likely to feel that you paid £50 for a £25 ticket. However, imagine that you have not pre-purchased your ticket, and get a £25 parking fine the day of your theatre trip. Will this affect your decision to see the play? Although you might feel annoyed about the parking fine this loss probably will not affect your decision to see the play in the same way as the first scenario. Why? In the first scenario you have spent your “play” budget on the lost ticket, whilst in the second scenario you have not.
To date, the concept of mental accounting has mostly been applied to the personal finance literature. Although some researchers have used the concept in a taxation context, they tend to focus at an individual (Hawkins & Wallace, 2006; Jackson, Shoemaker, Barrick & Burton, 2005) rather than an occupational or small business level (e.g., Adams & Webley, 2001; Ashby & Webley, 2008). Most western tax systems rely on individuals and businesses to pay income tax. Businesses are also relied on to pay and collect excise, payroll, property, and sales taxes, such as value added tax (VAT) and general sales tax (GST, Webley, 2004). Medium and large businesses individuals often have complex financial and managerial accounting systems in place. In contrast, small business and self-employed individuals — even if they have an accountant — tend to have a more “hands on” role in their finances. Consequently, the way in which self-employed and small business individuals think about tax money (that is, the mental account they place it in) could influence their behaviour towards it. In particular, the findings of Adams and Webley’s (2001) qualitative study revealed that whilst some small business individuals always see VAT money as belonging to the tax office and have a separate mental account for it, others do not distinguish it from their business turnover.
Perhaps unsurprisingly, respondents who conceptualised VAT monies as their own (rather than the tax offices) found it harder to part with. A typical comment was “VAT takes about £12 thousand a year from my business so I pay just as much in VAT as what I earn” (Adams & Webley, 2001). This contrasts nicely with a typical comment from those who did not perceive this sense of ownership: “It’s not a cost to the business, we’re just looking after the money for the government. There’s no point is worrying about paying. It’s their money” (Adams & Webley, 2001).
Similarly, Ashby and Webley (2008) found that the way in which different types of income were conceptualised was tied to respondents’ (self-employed hairdressers and beauticians) likeliness of paying tax on this income. Specifically, some hairdressers and beauticians put money from tips and weekend work, which should be declared to the tax office, into a mental account earmarked as theirs to spend as they wished (not to be declared), rather than into the same mental account as their daily income (to be declared). This finding speaks to Thaler’s (1999) question of whether mental accounting is normative, that is, is it normative in the hairdressing sector to place tips and money from out-of-hours work into a separate mental account? The issue of whether mental accounting practices are normative in occupational groups merits further investigation. Why? If they are then it might be possible for tax authorities to work with certain occupational groups to promote mental accounting practices in which taxable income (from all sources) is perceived as such (see Adams & Webley, 2001).
The present study
The present paper has two aims. First, it seeks to confirm that the concept of mental accounting is relevant in a taxation context. Second, it aims to explore whether mental accounting practices are tied to occupational group membership.
Study 1 addresses these aims by means of a focus group study. This methodology was chosen because group discussions are useful for bringing out key issues, and provide a rich and detailed source of data (see e.g., Hoppe, Wells, Wilsdon, Gillmore, & Morrison, 1994). Respondents were drawn from two distinct occupational groups (hairdressers and taxi drivers) to enable a comparison between the mental accounting practices of the groups. Following on from this, Study 2 — through the use of semi-structured interviews — aimed to replicate the findings of Study 1 with hairdressers in a different country (Australia). To achieve a broad sample of views in these industries males and females, with a varied range of experience, were included both studies.
Study 1
Method
Six in-depth, qualitative focus groups (three with hairdressers, and three with taxi-drivers) were carried out with a total of 20 participants in the South West of England. The hairdressers ranged in age from 17 to 51 years. Six (out of 10) were female. Seven were self-employed and all but one had an accountant. The taxi-drivers ranged in age from 29 to 65 years. Six (out of 10) were female. All were self-employed and 8 had an accountant.
A schedule with different questions was used as a guide for the focus groups. Only data relevant to mental accounting will be discussed here. Informed consent was gained from all participants. The hairdressing focus groups took place at the hairdressers’ salons (after closing time) and the taxi focus groups took place at the researcher’s university. Participants were offered £10 in payment. The focus groups lasted approximately 45-60 minutes and were tape-recorded. The tapes were fully transcribed and analysed using thematic analysis. Braun and Clarke’s (2006) scheme for carrying out a thematic analysis was used as a guide.
Results and discussion
The results of the present study confirm that the concept of mental accounting is relevant in a taxation context. Importantly, the findings also indicate that the way in which sources of extra income are conceptualised (and the mental account that they are placed in) is tied to occupational group membership. In particular, taxi drivers conceptualised tips as just another part of their daily income — mixing takings from taxi fares together with their tips. As one participant pointed out, it is difficult to keep track of what money is tip money, especially when busy:
The trouble is like you can’t really take your tips out, you dunno [sic] what you’ve done in tips like because on a busy Friday and Saturday night you’re on the go like bang bang bang [sic], you just check the money, give them the change and away you go.
Overall, the drivers had a pragmatic attitude towards tips being taxed. This was reflected in their conversations around tax and tipping, which focused on the way in which they organised their finances. For example, one participant talked about “bunging” her takings from taxi fares together with her tips and declaring all of it to the tax office, whilst another asked her accountant to ensure that any income she declares includes her tips.
In contrast, hairdressers conceptualised tips as a “gift” or a “bonus”, not as part of their daily income. Consequently, taxing tips was an altogether more emotive subject. As one participant said:
If you were to have said do we agree with the fact that we should have our tips taxed, then you would have a major uproar, we would all be ranting and raving, screaming at you because we have to declare our tips and they get taxed okay, the very word gratis is, is, it’s obviously in Latin and it’s a grateful, it’s a gratitude, it’s a thanks, it’s like a present, so it’s like saying to somebody I’m giving you ten pounds for your birthday, that is a present ok, somebody saying to me I’m giving you three pounds fifty for doing my hair as a present.
Indeed, despite legal requirements to declare tips, in line with Ashby and Webley’s (2008) findings, tips were placed into a mental account earmarked as “mine to spend as I wish” (not to be declared to the tax office). This is illustrated by one hairdresser’s statement that her tips “go into the shop next door.”
Study 2
Using a fresh sample of Australian hairdressers this study aimed to replicate and consolidate study the findings from Study 1. First, it aimed to show that mental accounting practices are relevant in a taxation context[1] in Australia as well as the UK. Second, it aimed to explore whether Australian hairdressers, like their UK counterparts, place tips into a different mental account to their daily income. Third, it aimed to explore whether mental accounting practices are used when thinking about sources of extra income other than tips.
Method
In-depth interviews were carried out with 15 participants from Sydney and Canberra in Australia. Participants ranged in age from 25 to 55 years. Ten owned or part-owned salons (9 of which employed staff) and 5 were employed. Thirteen had an accountant.
A schedule with different questions was used as a guide for the interviews. Only data relevant to mental accounting will be discussed here. Informed consent was gained from all participants. The interviews, which lasted approximately 20-40 minutes, took place at the hairdressers’ salons and were tape-recorded. Participants were offered the equivalent of £10 in payment. As in Study 1, the tapes were fully transcribed and analysed using thematic analysis.
Results and discussion
The results indicate that mental accounting is relevant in a taxation context in Australia as well as in the UK. Mental accounting practices were used when thinking about two sources of extra income: tips and money from out-of-hours haircuts. Although tipping was not seen as a large part of the Australian culture, nearly all of the respondents admitted to receiving some tips — especially from European and American clients. As one participant said, “I have got regular clients that do tip me when they come in, but no, it’s not a culture that we actually have a lot of in Australia.” In line with Study 1, tips were perceived as a gift or a bonus for “doing a good job” and were put into a separate mental account (to ordinary income) earmarked as “mine to spend as I wish.” As one participant said, “if you want to give me a 10-dollar tip you just give it to me and I put it in my pocket.” The Australian tax office expects hairdressers to declare tax on their tips — yet based on this small sample — it appears that they do not. Interestingly, nearly everyone failed to make the connection between taking their tips home and tax non-compliance. In particular, a respondent who described tips as an “extra” to be taken home said, “we pay our taxes, we don’t do anything that we feel we would be pulled up with, everything we do is above board.”
Although all of the respondents were salon-based, over half of the sample admitted to either doing haircuts out of salon hours themselves or knowing others that did. As one participant said, “the majority of hairdressers will probably do hair at home.” This money was seen as an “extra” or a “little bit of cream on top.” As one respondent put it, “it is something that you sort of do on the sly, just a little bit of extra pocket money.” Although some respondents recognised that this money should legally be declared to the tax office it seemed to be placed into a mental account labelled as “mine to spend as I wish.” This is illustrated in the below quote: