Research Papers

Taxes create deadweight loss by distorting consumer choice, so to the extent that consumers perceive taxes to be lower than they really are, deadweight loss declines. Deadweight loss is a convex function of perceived taxes, so its aggregate magnitude depends not only on the average tax misperception, but also on its heterogeneity among consumers. Aggregate data cannot reveal this heterogeneity, yet one can infer lower and upper bounds on deadweight loss relying solely on properties of aggregate demand. Sufficiently rich individual-level data permit identification of deadweight loss even with heterogeneous tax misperceptions. Under strong assumptions on the joint distribution of tax salience and preferences, survey data illustrate that tax salience heterogeneity can yield deadweight loss twice as large as one would calculate under the assumption of a homogeneous perceived price. Relaxing these assumptions, the unconstrained upper bound of deadweight loss is around fifty five times larger than the lower bound.

Forecasts of the consequences of tax changes usually assume that economic actors expect these changes are permanent, despite the inevitable political uncertainty that could lead to future reversals or further changes. This reasoning extends to when a firm's tax burden is correlated to the success of its ventures. We show how a firm's belief about how government policy is correlated with the input's marginal product distorts its risk profile, leading it to change its input decision. Generally speaking, input use will be discouraged if the firm faces high taxes precisely when the input is more productive. We show that in a world of policy uncertainty this holds under an arbitrary tax system, and in particular it holds even if inputs can be deducted from the firm's taxable income. Whenever the covariance between policy and payoff is zero, our model replicates the classical result that the deductibility of input expenses leaves the decision undistorted. We use this theoretical relationship in an empirical model of asset pricing to infer what investors believe about how future government policy correlates with their risky investments in different firms in the stock market.