Survey Measurement of Income Tax Rates.

Abstract

Despite widespread use of tax rate variables in both micro and macro-economic research, measurement of income tax rates has largely been ignored. When tax returns are unavailable, income variables are used to compute tax rates. Measurement error in income and unobserved deductions, exemptions and credits make these inherently noisy measures of true rates.

This dissertation reports new survey measures of average (ATR) and marginal (MTR) income tax rates from the Cognitive Economics Study (CogEcon). Survey measures are interpreted as tax rate perceptions, which are used to correct for survey noise when imputing true rates and then to characterize heterogeneity in misperceptions.

Chapter 1 advances a new survey methodology for measuring income tax rates. Data come from a panel of respondents' reported marginal tax rates, average tax rates and income in two subsequent waves of CogEcon. The individual measures of tax beliefs display heterogeneity, even after accounting for income and potential survey noise. Respondents systematically overestimate average tax rates and exhibit substantial heterogeneity. Perceptions of marginal tax rates are accurate at the mean, but exhibit mean reversion and substantial heterogeneity. Perceptions of marginal and average tax rates (conditional on the true rates) vary depending on cognitive ability, general financial knowledge and use of professional tax assistance.

Chapter 2 uses a finite mixture model to uncover heterogeneous income tax rate perceptions. This paper establishes four new results. First, almost half of respondents do not distinguish between marginal and average tax rates. Second, roughly 30 percent of respondents know the statutory marginal tax rates schedule (and answer questions accordingly). Third, among respondents who think all income is taxed at the same rate, roughly 40 percent think all of their income is taxed at the statutory marginal tax rate. Finally, respondents with higher cognitive ability are more likely to report statutory marginal tax rates, but only among respondents who prepare their own income tax returns.