Paul L. Caron

Wednesday, September 4, 2019

Rees-Jones & Taubinsky: Taxpayer Behavior Is Governed By Their Average Tax Rate, Not Their Marginal Tax Rate

Alex Rees-Jones (Cornell) & Dmitry Taubinsky (UC-Berkeley), Measuring “Schmeduling”:

What mental models do individuals use to approximate their tax schedule? Using incentivized forecasts of the U.S. Federal income tax schedule, we estimate the prevalence of the “schmeduling” heuristics for constructing mental representations of nonlinear incentive schemes. We find evidence of widespread reliance on the “ironing” heuristic, which linearizes the tax schedule using one’s average tax rate. In our preferred specification, 43% of the population irons. We find no evidence of reliance on the “spotlighting” heuristic, which linearizes the tax schedule using one’s marginal tax rate. We show that the presence of ironing rationalizes a number of empirical patterns in individuals’ perceptions of tax liability across the income distribution. Furthermore, while our empirical framework accommodates a rich class of other misperceptions, we find that a simple model including only ironers and correct forecasters accurately predicts average underestimation of marginal tax rates. We replicate our finding of prevalent ironing, and a lack of other systematic misperceptions, in a controlled experiment that studies real-stakes decisions across exogenously varied tax schedules. To illustrate the policy relevance of the ironing heuristic, we show that it augments the benefits of progressive taxation in a standard model of earnings choice. We quantify these benefits in a calibrated model of the U.S. tax system.

Figure 1

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Any taxpayer using tax software can determine his marginal tax rate in less than a minute. Add $1000 to income and see by how many dollars the tax refund decreases. Divide by 10 to get percentage marginal rate.

Posted by: AMTbuff | Sep 4, 2019 8:33:27 PM

And by aggregate taxes, not just income

Posted by: Mike Livingston | Sep 5, 2019 3:55:04 AM