Alex Raskolnikov has written an interesting, exasperating paper on The Cost of Norms: Tax Effects of Tacit Understandings.
The gist of his argument is that the various informal social norms and standards by which people come to arrangements — without having to draw up contracts or seek mediation by authorities — are quite valuable things. Because they are valuable things, when people rely on them in social situations, they are exchanging things of value without reporting this to the tax authorities and thus the State is missing out on lots of money.
One example of this shady underground economy of social norms is the one that is reported to exist in rural Shasta County. Don’t read this before bedtime if you’re prone to nightmares:
[Shasta County’s] farmers and ranchers build their relationships not by reference to their legal rights and obligations, but by relying on longstanding and pervasive norms of neighborliness. Neighbors help neighbors build, inspect, and repair fences, retrieve stray cattle, maintain the water supply, execute controlled burns, staff volunteer fire departments, and so on. They do not ask each other for payments, they do not enter into contracts, and they reject out of hand the idea of calling lawyers every time they do not like something their neighbors have done. Shasta County’s system of social control is built on shared understandings that are always unwritten, almost always unstated, and frequently unsupported by (or even contrary to) the relevant legal rules.
The world is clearly an uglier place than anybody knew, but Alex Raskolnikov has opened our eyes. Worse: “Shasta County is anything but unique. Researchers studying everyday commercial interactions have found similar informal practices everywhere they looked.”
…Shasta County inhabitants routinely engage in all sorts of commercial transactions that, if formalized, would produce tax consequences for one or both parties. Neighbors borrow (“rent,” in tax speak) each other’s equipment. They help each other with chores such as fence building and maintenance; that is, they provide services to each other. Occasionally, one neighbor supplies the other with building materials for a joint project. For tax purposes, this transfer may be characterized as a sale, depending on the circumstances.
Even this cursory analysis suggests that in the world of neighbors helping neighbors, one thing they may help each other do is reduce their tax liabilities.
Social welfare would be improved if the government could cheaply identify these norms and start treating them as legally binding contractual terms for tax purposes.
How would this improve social welfare?
Norm-based transactions allow taxpayers to reduce their tax burden, in effect shifting it to other taxpayers. The new law [one that would treat all of these norms as though they were formal contractual agreements, and tax them as such] will reduce these undesirable effects, that is, it will diminish the cost of norms.
In other words, by taxing the norms, you diminish their cost (you know, to society). For various reasons, though, it would be impractical and possibly even undesirable for the government to identify and formalize all such norms. For this reason, Raskolnikov suggests that the government use some heuristics to identify a subset of those norms that is likely to mask economic transactions with the potential for a big tax bite.
So the informal norms in Shasta County are safe… for now. “To be sure, these dealings sometimes allow inhabitants to reduce their tax liabilities, but there are good reasons to accept this cost and move on.”