Topic: Why Do Taxpayers Bunch at Notch Points? Experimental Evidence

Speaker: Michele Bernasconi (Ca' Foscari University of Venice) with Irene Buso (University of Bologna), Anna Marenzi (University of Venezia) and Dino Rizzi (University of Venezia) 

Time & venue:

Thursday, 12.15–1.30 p.m.

FU Berlin, Boltzmannstr. 16-20

room 202/ Kaminzimmer

Description: 

Fiscal policies frequently determine discontinuities in the average tax rate; for example, introducing fiscal benefits or flat-rate tax for those who report an income below a threshold produces a large discontinuous jump in tax liability – a notch – at the threshold. These notched tax schemes create strong and salient incentives to bunch below the threshold, either reducing their work or increasing non-compliance behaviour. Empirical evidence consistently reports a density hole above the notch point in the taxpayers‘ income distribution, but less than theoretically expected (e.g., Kleven and Waseem, 2013); experimental evidence supports the existence of bunching behaviour but not to the full extent what questions the understanding of incentives in notched fiscal systems (Gibson et al., 2019). More importantly, the empirical studies on bunching can hardly distinguish whether the bunching observed in reported income is due to an adjustment in labour supply or to misreporting.

We provide evidence of taxpayers‘ responses to incentives produced by the notch in personal income taxation in a controlled setting; we investigate how tax evasion possibilities influence bunching.  Four between-subject treatments with 90 subjects each are implemented in the laboratory: the earnings of a real-effort task based on sliders (Gill and Prowse, 2012) are taxed with (i) a proportional scheme without evasion possibilities, (ii) a proportional scheme with evasion possibilities (iii) a notched scheme without evasion possibilities, (iii) a proportional scheme with evasion possibilities, (iv) a notched scheme with evasion possibilities.

Results show clear evidence of bunching: bunching emerges in notched tax systems both with and without tax evasion. Furthermore, tax evasion possibilities do not crowd out labour supply adjustment: taxpayers react to notches by adjusting both effort and reported income.