Behavioral cross-influence of a shadow tax bracket: Evidence from bunching where income tax liabilities start

Abstract

Prediction of tax revenue must account for earnings responses with respect to all perceived incentives, whether they are effective or not. This paper explores the extent to which tax filers respond to irrelevant incentives and develops an identification procedure for the behavioral cross-influence (BCI), a behavioral elasticity created by Farhi and Gabaix (2020) to capture such responses. Relying on French income tax returns from 2008 to 2014, the BCI is identified from earnings responses to a shadow tax bracket located just below the threshold where French income tax liabilities start. Even tax filers who used to correctly optimize their taxable income react to an increase in irrelevant tax incentives. Far from being zero, the BCI represents between 56 % and 78 % of the elasticity of taxable income with respect to perceived incentives. Standard analysis restricted to effective incentives would underestimate this elasticity of taxable income by 60 %. Tax filers who face higher stakes are less likely to be misled by irrelevant incentives.