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Paying to save: tax withholding and asset allocation among low- and moderate-income taxpayers

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  • Michael S. Barr
  • Jane K. Dokko

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. Present-biasedness and dynamic inconsistency among LMI tax filers have important implications for saving policies and tax administration.

Suggested Citation

  • Michael S. Barr & Jane K. Dokko, 2008. "Paying to save: tax withholding and asset allocation among low- and moderate-income taxpayers," Finance and Economics Discussion Series 2008-11, Board of Governors of the Federal Reserve System (U.S.).
  • Handle: RePEc:fip:fedgfe:2008-11
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    References listed on IDEAS

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    2. Robert B. Barsky & Miles S. Kimball & F. Thomas Juster & Matthew D. Shapiro, 1995. "Preference Parameters and Behavioral Heterogeneity: An Experimental Approach in the Health and Retirement Survey," NBER Working Papers 5213, National Bureau of Economic Research, Inc.
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    4. Esther Duflo & William Gale & Jeffrey Liebman & Peter Orszag & Emmanuel Saez, 2006. "Saving Incentives for Low- and Middle-Income Families: Evidence from a Field Experiment with H&R Block," The Quarterly Journal of Economics, Oxford University Press, vol. 121(4), pages 1311-1346.
    5. Christina Paxson, 1990. "Borrowing Constraints and Portfolio Choice," The Quarterly Journal of Economics, Oxford University Press, vol. 105(2), pages 535-543.
    6. Loewenstein, George F & Sicherman, Nachum, 1991. "Do Workers Prefer Increasing Wage Profiles?," Journal of Labor Economics, University of Chicago Press, vol. 9(1), pages 67-84, January.
    7. Christopher D. Carroll, 1997. "Buffer-Stock Saving and the Life Cycle/Permanent Income Hypothesis," The Quarterly Journal of Economics, Oxford University Press, vol. 112(1), pages 1-55.
    8. Christopher D. Carroll, 1992. "The Buffer-Stock Theory of Saving: Some Macroeconomic Evidence," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 23(2), pages 61-156.
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    11. Paul A. Samuelson, 2011. "Lifetime Portfolio Selection by Dynamic Stochastic Programming," World Scientific Book Chapters,in: THE KELLY CAPITAL GROWTH INVESTMENT CRITERION THEORY and PRACTICE, chapter 31, pages 465-472 World Scientific Publishing Co. Pte. Ltd..
    12. Shapiro, Jesse M., 2005. "Is there a daily discount rate? Evidence from the food stamp nutrition cycle," Journal of Public Economics, Elsevier, vol. 89(2-3), pages 303-325, February.
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    Cited by:

    1. Berg, Nathan & Kim, Jeong-Yoo, 2010. "Demand for Self Control: A model of Consumer Response to Programs and Products that Moderate Consumption," MPRA Paper 26593, University Library of Munich, Germany.

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