by Peter Katuscak (CERGE-EI, Prague)
23/04/2009 h 12:00
Economic theory assumes that taxpayers use their true marginal tax rate (MTR) to guide their economic decisions. However, complexity of the personal income tax system implies that taxpayers may incorrectly perceive true marginal prices and incentives. We first develop an updating model that formalizes this conjecture. A prediction of the model is that an unexpected increase in the previous year’s tax liability pushes up the perception of the MTR in the current year, even though the MTR is not in fact changing. Then, assuming that taxpayers react to their perceived after-tax price as economic theory would suggest, we test this prediction empirically by examining whether household labor income responds to predictable (but not necessarily predicted) lump-sum variation in the previous year’s tax liability due to loss of eligibility for the Child Tax Credit when the eligible child turns
JEL Classification: H21, H24, H31.