No. 108: Firms’ Tax Misperception

Abstract

Firm managers consider tax implications when making business decisions. Their perception of the tax burden shapes how they incorporate taxes into their reasoning. We investigate how decision-makers in small and medium-sized firms perceive their firm’s tax rates and how their perception differs from actual tax rates. We quantify their misperception of average tax rates (ATR) and marginal tax rates (MTR) and identify the main drivers of these misperceptions. We collect survey data on perceived tax rates of German firms of different legal forms and contrast them with actual tax rates derived from administrative tax return data. We find that the share of firm managers who considerably misperceive their ATR (MTR) is more than 66% (55%). We find that sole proprietorships and partnerships considerably overestimate their ATR on average. Corporate decision-makers, for their part, tend to overestimate tax rates on retained profits but underestimate ATRs and MTRs on distributed profits. Irrespective of the legal form, our results suggest that tax misperception is primarily influenced by the firm size, the complexity of the tax system, a lack of tax literacy, and a dissatisfaction with the tax system. We also find that misperception is likely to distort investment decisions, especially under a progressive tax schedule. Policymakers and researchers need to be aware of firms’ tax misperception when discussing and evaluating tax policy.