Paying to Save: Tax Withholding and Asset Allocation among Low- and Moderate-Income Taxpayers

45 Pages Posted: 4 Jul 2007 Last revised: 15 Jan 2008

See all articles by Jane Dokko

Jane Dokko

Federal Reserve Bank of Chicago

Michael S. Barr

University of Michigan Law School; University of Michigan at Ann Arbor - Gerald R. Ford School of Public Policy; University of Michigan, Center on Finance, Law, and Policy

Multiple version iconThere are 2 versions of this paper

Date Written: November 29, 2007

Abstract

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.

Keywords: LMI tax filers, withholding preference, portfolio allocation

JEL Classification: C42, H2, H83, K34

Suggested Citation

Dokko, Jane and Barr, Michael S., Paying to Save: Tax Withholding and Asset Allocation among Low- and Moderate-Income Taxpayers (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. Available at SSRN: https://ssrn.com/abstract=997866 or http://dx.doi.org/10.2139/ssrn.997866

Jane Dokko (Contact Author)

Federal Reserve Bank of Chicago ( email )

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Michael S. Barr

University of Michigan Law School ( email )

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University of Michigan at Ann Arbor - Gerald R. Ford School of Public Policy ( email )

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University of Michigan, Center on Finance, Law, and Policy ( email )

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