Working Paper: NBER ID: w22884
Authors: Alex Rees-Jones; Dmitry Taubinsky
Abstract: 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.
Keywords: Income Tax; Heuristics; Tax Perception; Behavioral Economics
JEL Codes: D03; D04; D1; H0; K34
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| reliance on heuristics (D91) | misoptimized responses to tax incentives (H32) |
| ironing heuristic (D80) | overestimation of taxes paid by low-income earners (H31) |
| ironing heuristic (D80) | underestimation of taxes paid by high-income earners (H26) |
| income (E25) | tax perception biases (H22) |
| ironing heuristic (D80) | underestimation of marginal tax rates (H31) |
| presence of ironing (L61) | increases welfare benefits of progressive taxation (H31) |