Taxes and Mistakes: What's in a Sufficient Statistic?

Abstract

What determines the efficiency cost of taxation in the presence of optimization errors? Employing recent results quantifying efficiency cost when consumers are subject to biases, this paper shows how budget adjustment rules, debiasing, and the nature of tax perception affect efficiency cost. Budget adjustment rules govern how taxpayers meet their budget constraint in spite of misperceptions. Complete consideration of budget adjustment rules shows why simply detecting misperception of taxes is insufficient for welfare. Furthermore, if consumers "debias" at sufficiently high stakes, policymakers' attempts to exploit biases to reduce inefficiency — like switching from high- to low-salience taxes — can actually increase inefficiency. Any cognitive costs of debiasing exacerbate this "curse of debiasing." I demonstrate that the model can be applied to even complicated misperceptions using the example of "ironing," which leads to a clarification of prior welfare analysis of ironing.

Keywords: behavioral tax, tax salience, applied theory, excess burden

JEL Classification: H210, H310, D110