February 2019
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71 Reads
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3 Citations
Scandinavian Journal of Economics
Income tax collection in most advanced economies uses third‐party withholding for wage income by employers. Since withholding taxes do not necessarily reflect true effective taxes, they may give false signals on net‐of‐tax pay. We test labor supply responses to such misperceptions using laboratory experiments. Withholding taxes (and resulting tax refunds) should be behaviorally neutral, but our results show that tax adjustments lead to effort adjustments – suggesting that withholding blurs tax incentives. While there is no statistically significant response in the overall sample, the subgroup of participants who self‐assess as motivated by monetary incentives (about half of the total sample) reduces effort in response to withholding taxes and increases effort after receiving tax refunds. This article is protected by copyright. All rights reserved.