Misperceptions of Nonlinear Budget Sets: Evidence from Administrative Tax Data

Alexander M. Gelber; Damon Jones; Ithai Lurie; Daniel W. Sacks

doi:10.3386/w33496

Misperceptions of Nonlinear Budget Sets: Evidence from Administrative Tax Data

Alexander M. Gelber, Damon Jones, Ithai Lurie & Daniel W. Sacks

Working Paper 33496

DOI 10.3386/w33496

Issue Date February 2025

Budget set kinks are much studied in economics, including in the context of “bunching” estimators that assume individuals react to the true marginal tax rate. We document that individuals disproportionately “left-bunch” below kinks in the context of the Social Security Earnings Test where incentives from its actuarial adjustments should instead push many rational agents to bunch above the kink. We show that the left bunching in this case cannot be explained through standard, rational reactions to the incentives. We demonstrate that these patterns represent the first empirical evidence consistent with “spotlighting,” wherein individuals misperceive the local marginal tax rates as applying throughout the tax schedule and therefore treat the kink as a notch. In the context of the Earnings Test, this misperception provides an explanation for why literature has found large earnings responses despite the fact that the Earnings Test typically creates weak incentives for rational agents to adjust earnings. More generally, if individuals perceive kinks as notches, then elasticities estimated from bunching at kinks where this misperception may be at play may be significantly over-estimated.

This research was completed partly while Gelber was on leave at the Stanford Institute for Economic Policy Research, partly funded by a grant from the Alfred P. Sloan foundation. This research was conducted while Ithai Lurie was an employee at the U.S. Department of the Treasury. The findings, interpretations, and conclusions expressed in this paper are entirely those of the authors and do not necessarily reflect the views or the official positions of the U.S. Department of the Treasury. Any taxpayer data used in this research was kept in a secured IRS data repository, and all results have been reviewed to ensure that no confidential information is disclosed. For helpful comments we thank seminar participants at Stanford. All errors are our own. The research reported herein was also performed pursuant to grant RDR18000003 from the US Social Security Administration (SSA) funded as part of the Retirement and Disability Research Consortium. The opinions and conclusions expressed are solely those of the author(s) and do not represent the opinions or policy of SSA, any agency of the Federal Government, or NBER. Neither the United States Government nor any agency thereof, nor any of their employees, makes any warranty, express or implied, or assumes any legal liability or responsibility for the accuracy, completeness, or usefulness of the contents of this report. Reference herein to any specific commercial product, process or service by trade name, trademark, manufacturer, or otherwise does not necessarily constitute or imply endorsement, recommendation or favoring by the United States Government or any agency thereof. The views expressed herein are those of the authors and do not necessarily reflect the views of the National Bureau of Economic Research.

Alexander M. Gelber
I served as Deputy Assistant Secretary for Economic Policy at the U.S. Treasury from June 2012 to June 2013 (and as Acting Assistant Secretary during part of this period). In these capacities, I served as a member of the Social Security Trustees Working Group.

In 2019-20 I served a member of the Social Security Advisory Board Technical Panel on Assumptions and Methods.

This research was supported by the U.S. Social Security Administration through grant #RRC08098400-06-00 to the National Bureau of Economic Research as part of the SSA Retirement Research Consortium and by grant #G-2015-14005 from the Alfred P. Sloan Foundation. The findings and conclusions expressed are solely those of the authors and do not represent the views of SSA, any agency of the Federal Government, or the NBER. The research was also supported by the UC Berkeley Institute for Research on Labor and Employment, UC Berkeley Center on Governing and Investing for the Future, and UC Berkeley Burch Center.

I have no other relevant or material financial interests that relate to the research described in this paper.

IRB approval was not obtained for this study as the nature of the data used for the study render the project exempt.

Damon Jones
Damon Jones previously served as a senior economist in the Council of Economic Advisers within the Executive Office of the President of the United States.
MARC RIS BibTeΧ

Misperceptions of Nonlinear Budget Sets: Evidence from Administrative Tax Data

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