Measuring the Welfare Cost of a Misperceived Tax: Evidence from College Financial Aid

College financial aid in the US creates a large implicit tax on parent income. Like many taxes, it is difficult to learn one’s tax rate. Using federal tax data, we provide the first estimates of the response of parent income to the college aid implicit tax (elasticity = .04). We show how to combine the elasticity with survey data to identify deadweight loss from the tax, given that individuals misperceive their tax rate. Misperception of the college aid implicit tax increases deadweight loss by 127%, driven by substantial heterogeneity in misperception across individuals.