Finance and Economics Discussion Series

Taxpayer Confusion over Predictable Tax Liability Changes: Evidence from the Child Tax Credit

Naomi E. Feldman, Peter Katuscak, and Laura Kawano
2013-66

Abstract: We develop a model of how taxpayers update beliefs over their tax rates when they encounter a non-salient tax liability change. We test the model's hypotheses using the loss of the Child Tax Credit when a child turns 17. Because this tax liability change is lump-sum and predictable, there should be no reaction in labor income if taxpayers are fully informed. Using this age discontinuity, we find, however, that losing the credit reduces household labor income. This finding suggests that taxpayers misperceive the source of tax liability changes, leading to under- or over-reactions to changes in marginal tax rates.

Keywords: Tax salience, tax complexity