Working Paper（26-021E）Tax Ironing and Its Implications for US Business Cycles

This paper investigates the macroeconomic effects of tax ironing, the misperception of the average tax rate as the marginal tax rate. Existing micro evidence indicates that about 43 percent of US taxpayers iron. Using US tax law and household microdata, I measure the tax progressivity perceived by correct perceivers and ironers and incorporate these measures into a medium-scale DSGE model with tax ironing. Based on the estimated model, I find that ironing raises steady-state economic activity by about one percent and modestly improves steady-state welfare. In contrast, its effects on business-cycle moments are tiny. Allowing for tax ironing barely improves the model’s marginal likelihood.

Keywords: Tax ironing; tax progressivity; tax misperception; business cycles; Bayesian estimation

JEL Classifications: E32, E62, H24, D91