Planet Money Summer School 2: How Taxes Change Behavior and the Economy

Episode Release Date: July 16, 2025
Host: Robert Smith
Guest Expert: Professor Derek Hamilton, Henry Cohen Professor of Economics and Urban Policy at the New School

Introduction to the Role of Government in the Economy

Robert Smith kicks off the episode by framing taxes not just as a means for the government to raise revenue but as powerful tools that can shape economic behavior and societal values. He emphasizes the evolving nature of taxation from its early uses, such as tariffs on imported goods and property taxes, to more complex instruments like corporate and sales taxes introduced in the early 1900s.

Robert Smith [00:34]: "We all know this, right? Fund the military, insurance programs like Medicare and Medicaid, roads, bridges, all the stuff. That part is pretty straightforward."

Key Topics Covered:

• Revenue Generation: Traditional view of taxes funding government expenditures.
• Behavioral Influence: Modern perspective on taxes altering economic actions and societal norms.
• Tax Code Complexity: How deductions and incentives within the tax system guide personal and corporate behavior.

Case Study: The Earned Income Tax Credit (EITC)

Professor Derek Hamilton delves into the EITC as a prime example of taxes being used to redistribute income and encourage work. The discussion highlights the EITC's design to provide financial bonuses to low-income workers, thereby uplifting them economically.

Derek Hamilton [04:35]: "And you are describing the ways in which we structure behavior and frankly structure inequality by way of our tax code."

The episode features narratives from individuals like Lynn Matthews and Mariano Choa, illustrating the tangible impacts of the EITC on their lives. These stories underscore how the EITC not only provides immediate financial relief but also facilitates long-term economic advancement through education and improved living conditions.

Mariano Choa [13:50]: "No, no, no, no. Because my income is low. It's low income."

Key Insights:

• EITC as a Redistribution Tool: Transfers cash to low-income individuals, effectively redistributing wealth.
• Incentivizing Employment: Encourages recipients to maintain or increase their income without losing benefits abruptly.
• Economic and Social Mobility: Facilitates access to education, better housing, and debt repayment.

Understanding Progressive and Regressive Taxes

The episode contrasts progressive and regressive taxation systems, explaining how they differently impact various income groups based on the economic principle of marginal utility.

Professor Derek Hamilton [18:27]: "A flat tax is a regressive tax."

Definitions:

• Progressive Taxation: Higher earners pay a larger percentage of their income in taxes, reflecting the lower marginal utility of additional income to them.

  Derek Hamilton [36:55]: "Progressive taxation would suggest that those who can least afford to pay the tax pay a lower rate than those who can most afford to pay it."

• Regressive Taxation: Lower earners pay a higher percentage of their income, placing a greater relative burden on them.

  Derek Hamilton [18:29]: "Everybody pays 12% of their income. That's regressive because some people just have lower incomes."

Discussion Points:

• Marginal Utility: Additional dollars have greater value to lower-income individuals compared to the wealthy.
• Policy Implications: Progressive taxes aim to align tax burdens with individuals' ability to pay, promoting economic equity.

Pigouvian Taxes and Addressing Externalities

A significant portion of the episode is dedicated to Pigouvian taxes, named after economist Arthur Pigou, which are designed to correct negative externalities—unintended adverse effects of economic activities on third parties.

Historical Context:

• Arthur Pigou's Contribution: Introduced the concept of negative externalities and proposed taxes to internalize these external costs.

  NPR [27:26]: "He was the person who gave us this whole framework for thinking about negative externalities."

Case Studies:

• London Fog and Pollution: Pigou identified the societal costs of air pollution from coal burning, such as health issues and property damage, which were not accounted for by the polluters.

  NPR [30:49]: "That's his famous graph. And what this graph said for the first time to the whole entire world was that you had to put a price on these problems or they would never be solved."

• Modern Applications: Carbon taxes in countries like Canada and New Zealand, and congestion taxes in Manhattan, which have successfully reduced traffic and pollution while funding public transit improvements.

  Robert Smith [32:26]: "We have this progressive income tax code in the United States, and maybe you can say we do it because it's the right thing to do. But there's an economic way to think about progressive taxation, and that's through this concept called marginal utility."

Challenges and Unintended Consequences:

• Measurement Difficulties: Accurately quantifying the societal cost of externalities remains complex.

  Mariano Choa [31:05]: "You could calculate that cost and force the guilty parties to pay for it."

• Behavioral Shifts: Taxes may lead to unintended shifts in behavior, such as consumers opting for alternative harmful products when one is taxed.

  Robert Smith [34:08]: "One way is that people find a way to avoid the taxes. Maybe they don't have a sugary drink, but they spend it on something else that's bad for them."

Notable Quotes:

Derek Hamilton [34:00]: "You always have to think with these taxes. You're not just discouraging one thing, you may be encouraging people to shift to another thing."

Vocabulary and Economic Concepts

The episode concludes by reinforcing key economic terms that underpin the discussion on taxation:

• Progressive Taxation: Higher earners pay a higher percentage of their income.
• Marginal Utility: The additional satisfaction or value derived from an extra unit of a good or service.
• Negative Externality: An adverse effect of an economic activity on unrelated third parties.
• Pigouvian Tax: A tax imposed on activities that generate negative externalities to correct an inefficient market outcome.

Example Illustration:

• Junk Mail Tax: Professor Hamilton humorously suggests taxing junk mail to address the societal costs of wasted time and environmental impact from recycling.

  Derek Hamilton [35:29]: "Stop sending me junk mail."

Conclusion and Takeaways

Robert Smith wraps up the episode by highlighting how taxes, when thoughtfully designed, can be powerful instruments for social and economic change. From redistributing income through the EITC to addressing environmental issues with Pigouvian taxes, the episode underscores the multifaceted role of taxation in shaping a more equitable and sustainable economy.

Robert Smith [38:05]: "The way to fix a negative externality is a Pigouvian tax. Put the real cost of societal harm into the price of the product and let the market decide if it's worth it."

Final Thoughts:

• Tax Policy as a Reflection of Societal Values: The choices embedded in tax codes mirror what a society prioritizes and values.
• Economic and Social Empowerment: Properly structured taxes can empower individuals, promote fairness, and address collective challenges.

Stay Tuned:
Next week's episode will delve into government spending choices and the economic principles guiding where tax revenue is allocated.

This summary is based on the transcript provided and aims to encapsulate the key discussions and insights shared during the "Summer School 2: How Taxes Change Behavior and the Economy" episode of Planet Money.