Taxes and Mistakes: What's in a Sufficient Statistic?
Daniel H. Reck
University of Michigan at Ann Arbor - Department of Economics
February 1, 2014
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 source of bias 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. An application to “ironing” — the confusion of average and marginal tax rates — leads to a clarification of prior welfare analysis of ironing. Finally, 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.”
Number of Pages in PDF File: 43
Keywords: behavioral tax, tax salience, applied theory, excess burden
JEL Classification: H210, H310, D110
Date posted: May 23, 2013 ; Last revised: February 2, 2014
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