Measuring "Schmeduling"

Alex Rees-Jones, Dmitry Taubinsky

NBER Working Paper No. 22884
Issued in December 2016, Revised in June 2018
NBER Program(s):Aging, Law and Economics, Labor Studies, Public Economics

What mental models do individuals use to approximate their tax schedule? Using an incentivized income-tax forecasting task, we estimate the prevalence of the “schmeduling” heuristics for constructing mental representations of nonlinear incentive schemes. We find evidence of widespread adoption of 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 adoption of 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. This paves the way for tractably incorporating tax misperceptions into standard analysis of income tax reforms. As an illustration, we show that ironing 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.

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Document Object Identifier (DOI): 10.3386/w22884

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