An income tax withholding model: Pervasiveness of overpayment

Abstract

The U.S. government mandates taxpayers remit taxes through a "pay as you go" system. Research indicates employees continue to overpay interim taxes, despite the inefficiencies of this form of forced savings. Theory holds that a rational individual would choose the minimum amount of withholdings prescribed by the tax code. We adopted Kahneman-Tversky (1979) prospect theory to show that, under reasonable conditions, individuals will continue to choose excessive withholdings. This paper is not an attempt to statistically justify prospect theory however; we argue that withholdings increase when the income tax rate increases and when beforetax income increases. Our model extends the income tax withholding literature by modeling a framework to determine an optimal withholding decision for taxpayers.

Citation

Lien, D. and Smith, P.C. (2010), "An income tax withholding model: Pervasiveness of overpayment", Journal of Public Budgeting, Accounting & Financial Management, Vol. 22 No. 3, pp. 325-342. https://doi.org/10.1108/JPBAFM-22-03-2010-B002