Taxes, Prices, and Consumer Protection

Abstract

Should market prices include or exclude taxes? Market prices in U.S. do not include sales taxes and similarly prices in Canada are tax-exclusive. But in many other countries exclusion of taxes is considered misleading, and thus consumer protection laws regulate tax-inclusive pricing. This paper explains, based on optimal tax analysis, that the opposite is true. To the extent that tax-exclusive pricing confuses consumers who hence ignore non-indicated taxes, consumers are better off, and therefore, tax-exclusive pricing is socially desirable. The argument is counter-intuitive, in particular for consumer protection advocates: confusion is actually good for consumers. The paper further investigates other potential rationales for tax-inclusive pricing, and shows that a reasonably accepted justification is rather limited in scope and unrelated to consumer protection motivations. Finally, the paper extends the analysis to wage taxes and to misleading non-tax (marketing) practices.

Keywords: optimal taxation, price presentation, cognitive bias, tax-exclusive, tax-inclusive

JEL Classification: D18, D3, D6, D83, H21, H23, H71, K2, K34, M3