Abstract
I investigate by experiment the tax rate used by individuals when making marginal economic decisions. I find that there are at least as many individuals who use the average tax rate ‘as if’ it is the marginal tax rate, as individuals who use the true marginal tax rate. The cause of the widespread use of the average tax rate is shown to be the presentation of the tax table: almost all individuals use the true marginal tax rate if the tax table is redesigned to stress the marginal rate. However, the misperception is socially beneficial: using reasonable parameter estimates, it lowers the excess burden of a typical household by 43%, and is likely to make all households better-off.
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