No abstract

Tax provisions that reduce deductions and credits by imposing floors and phase-outs have become an increasingly popular tool used by Congress. However, these provisions also obscure the marginal tax rate, thereby potentially impairing the ability of taxpayers to make optimal decisions. We investigate the effects of floors and phase-outs on taxpayers' ability to determine their correct marginal tax rates and how this may affect tax-rate-dependent investment decisions. To investigate these potential effects we created an experimental setting in which taxpayers (89 M.B.A. students) were asked to maximize their after-tax income by choosing between a taxable and nontaxable bond. Each participant was assigned to one of three experimental tax systems: low complexity with no floors or phase-outs, medium complexity with one floor, and high complexity with both a floor and phase-out. The effective marginal tax rate was the same in each condition. The results indicate that decision performance was significantly better for participants facing the low complexity system than those in the medium or high complexity systems.

This study examines the effect of timing (gradual versus immediate) and direction (tax increase or decrease) of a tax change on taxpayer behavior. Specifically, we focus on capital gain tax changes and preferences for investment in riskier assets. We run an experiment with 117 participants who allocate investment dollars between two funds of differing risk. Drawing on mental accounting and hedonic editing (Thaler 1985; Thaler and Johnson 1990), we posit that a tax decrease (a “gain”) implemented gradually over several years will result in a greater increase in risky investment once the decrease is fully implemented than when the tax change is implemented all at once. In contrast, once a tax increase (a “loss”) is fully implemented, a smaller decrease in risky investment will result when the change occurs all at once rather than gradually. Our findings support these expectations, suggesting that the manner of implementing a tax law change may impact decisions. Data Availability: Contact the authors.

In an online experiment, the immediate (Roth) versus deferred taxation of retirement income affects taxpayers' investment decisions such that tax-deferred plan investors under-adjust for future tax burdens and overestimate their future wealth compared to Roth investors. When presented with a specific, after-tax monetary goal, Roth account holders invest more in higher-risk, higher-return assets than tax-deferred account holders. We investigate four aspects of this investment context that could alleviate these differences: 1) implementing a "do-your-best" goal, 2) reframing specific goals in pre-tax dollars, 3) explicitly prompting investors to estimate future tax burdens, and 4) providing performance feedback. These interventions reduce differences between Roth and tax-deferred investor behaviors, but do not entirely close the gap on their own. In combination, reframing goals and prompting future tax estimations encourage tax-deferred account holders to invest in risky assets to the same degree as Roth investors only when paired with performance feedback.

In this study, we construct explanations for the taxation of social security benefits based on previously identified dimensions of fairness (exchange, horizontal, and vertical equity). We then conduct an experiment to examine whether providing senior citizen taxpayers with explanations increases the perceived fairness of taxing social security. The results indicate that for those subjects with the greatest self-interest (subjects currently taxed on a portion of their social security benefits), the exchange equity explanation had the most consistent positive effects on both acceptance of the explanation and on the perceived fairness of taxing social security benefits. On the other hand, for those subjects not currently taxed on their social security benefits, the vertical equity explanation was more likely to be accepted than either the exchange or horizontal equity explanation. However, while these subjects agreed with the vertical equity explanation, it did not increase their fairness perceptions. These findings illustrate how important it is for tax policy makers striving to increase perceptions of fairness to carefully consider and develop explanations for tax provisions.