The Impact of Floors and Phase-Outs on Taxpayers' Decisions and Understanding of Marginal Tax Rates

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.

Tax Compliance Costs: A Review of Cost Burdens and Cost Structures

“…child tax credits, deductibility of certain private expenses) account in detail for the capability of taxpayers to pay their fair share to the society and should, therefore, result in a more 'equal' post-tax income distribution (Kaplow, 1996). On the other hand, complex tax rules imply the necessity of interpretations and the possibility of making mistakes (De bartolome, 1995;Rupert, Single and Wright, 2003), which may either result in too high or too low tax payments when compared to those enhancing the ' equal' distribution. As a result, complex rules might provide tax planning opportunities for certain well-informed taxpayers.…”

“…For example, the especially high burden of self-employed taxpayers and small businesses may reduce the number of business startups (Djankov et al, 2002). In addition, research provides evidence that tax complexity can result in economically wrong decisions (Rupert, Single and Wright, 2003), influences risktaking behavior (Ackermann, Fochmann and Mihm, 2013), increases the demand for tax advice (Christian, Gupta and Lin, 1993; and affects the willingness of taxpayers to comply with tax rules (Alm, Jackson and McKee, 1992;Erard and Ho, 2003;Alm et al, 2010).…”

Tax Rate Biases in Tax Planning Decisions: Experimental Evidence

“…Our findings suggest that, particularly in complex situations (Rupert, Single, and Wright 2003), corporate taxpayers could have underestimated effects of tax-base broadening (e.g., limitations for the use of tax loss carry-forward) and insufficiently adapted their tax-planning strategies. This seems plausible as the public debate on taxation focuses more strongly on tax-rate than on tax-base changes, which contributes to tax-rate salience.…”

Tax Compliance Costs: A Review of Cost Burdens and Cost Structures

“…For example, the especially high burden of selfemployed taxpayers and small businesses may reduce the number of business start-ups (Djankov et al 2002). In addition, research provides evidence that tax complexity can result in economically wrong decisions (Rupert, Single, and Wright 2003), influences risk-taking behavior (Ackermann, Fochmann, and Mihm 2013), increases the demand for tax advice (Christian, Gupta, andLin 1993, Eichfelder et al 2012) and affects the willingness of taxpayers to comply with tax rules (Alm, Jackon, and McKee 1992, Erard and Ho 2003, Alm et al 2010.…”

“…child tax credits, deductibility of certain private expenses) account in detail for the capability of taxpayers to pay their fair share to the society and should, therefore, result in a more 'equal' post-tax income distribution (Kaplow 1996). On the other hand, complex tax rules imply the necessity of interpretations and the possibility of making mistakes (De Bartolome 1995, Rupert, Single, andWright 2003), which may either result in too high or too low tax payments when compared to those enhancing the 'equal' distribution. Hence, complex rules might provide tax planning opportunities for certain well-informed taxpayers.…”