The Use of Marginal Tax Rates in Decision Making: The Impact of Tax Rate Visibility.

Abstract Taxpayers need to know their marginal tax rate to make optimal decisions, for instance, in choosing between work and leisure or between taxable and tax-exempt bonds. However, previous studies (e.g., Rupert and Fischer 1995; Fujii and Hawley 1988) have shown that many individual taxpayers either do not accurately recall or are unaware of their marginal tax rates. This study examines the impact of the visibility of the marginal tax rate (MTR) on taxpayer decision making. In addition, the effect of visibility on the rate of learning is examined. It is hypothesized that greater visibility will lead to better decision performance and more rapid learning as a result of task properties feedback. To investigate these issues, subjects in a computerized experiment were presented with a series of 11 periods in which they were given an investment choice between a taxable and nontaxable savings account. Visibility of the rate structure was treated as a between-subjects variable with four conditions, ranging from no indication of the MTR (low visibility) to explicit identification of the MTR as provided by the tax rate schedule (high visibility). Results indicate that increased visibility of the rate structure significantly enhanced decision performance. Further, learning was most rapid for the high visibility conditions. Implications of the results for policy makers, practitioners and researchers are discussed.