Paying to Save: Tax Withholding and Asset Allocation among Low- and Moderate-Income Taxpayers
University of Michigan
Michael S. Barr
University of Michigan Law School
November 29, 2007
2nd Annual Conference on Empirical Legal Studies Paper
U of Michigan Public Law Working Paper No. 100
U of Michigan Law & Economics, Olin Working Paper No. 07-22
We analyze the phenomenon that low- and moderate-income (LMI) tax filers exhibit a "preference for over-withholding" their taxes, a measure we derive from a unique set of questions administered in a dataset of 1,003 households, which we collected through the Survey Research Center at the University of Michigan. We argue that the relationship between their withholding preference and portfolio allocation across liquid and illiquid assets is consistent with models with present-biased preferences, and that individuals exhibit self-control problems when making their consumption and saving decisions. Our results support a model in which individuals use commitment devices to constrain their consumption. Using data on other tax-filing behaviors, we also show that mental accounting and loss aversion explanations for tax filers' "preference for over-withholding" are unlikely to explain the patterns in the data. Dynamic inconsistency among LMI tax filers has important implications for saving policies and for tax administration at large.
Number of Pages in PDF File: 45
Keywords: LMI tax filers, withholding preference, portfolio allocation
JEL Classification: C42, H2, H83, K34
Date posted: July 4, 2007 ; Last revised: January 15, 2008
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