Behavioral Effects of Withholding Taxes on Labor Supply

Johannes Becker, Jonas Fooken and Melanie Steinhoff

Scandinavian Journal of Economics, 2019, vol. 121, issue 4, 1417-1440

Abstract: In most advanced economies, income tax collection uses third‐party withholding for wage income. Because withholding taxes do not necessarily reflect true effective taxes, these may give false signals of net‐of‐tax pay. We test labor supply responses to such misconceptions using laboratory experiments. Withholding taxes (and the resulting tax refunds) should be behaviorally neutral, but our results show that tax adjustments lead to effort adjustments, which suggests that withholding blurs tax incentives. While there is no statistically significant response in the overall sample, the participants in the subgroup who self‐assess to be motivated by monetary incentives (about half of the total sample) reduce their effort in response to withholding taxes and increase their effort after receiving tax refunds.

Date: 2019
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Working Paper: Behavioral Effects of Withholding Taxes on Labor Supply (2018)
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