Optimal Taxation with Behavioral Agents

54 Pages Posted: 8 Sep 2015

See all articles by Emmanuel Farhi

Emmanuel Farhi

Harvard University - Department of Economics; National Bureau of Economic Research (NBER)

Xavier Gabaix

Harvard University - Department of Economics; National Bureau of Economic Research (NBER); Centre for Economic Policy Research (CEPR); European Corporate Governance Institute (ECGI)

Date Written: September 2015

Abstract

This paper develops a theory of optimal taxation with behavioral agents. We use a general behavioral framework that encompasses a wide range of behavioral biases such as misperceptions, internalities and mental accounting. We revisit the three pillars of optimal taxation: Ramsey (linear commodity taxation to raise revenues and redistribute), Pigou (linear commodity taxation to correct externalities) and Mirrlees (nonlinear income taxation). We show how the canonical optimal tax formulas are modified and lead to a rich set of novel economic insights. We also show how to incorporate nudges in the optimal taxation frameworks, and jointly characterize optimal taxes and nudges. We explore the Diamond-Mirrlees productive efficiency result and the Atkinson-Stiglitz uniform commodity taxation proposition, and find that they are more likely to fail with behavioral agents.

Suggested Citation

Farhi, Emmanuel and Gabaix, Xavier, Optimal Taxation with Behavioral Agents (September 2015). NBER Working Paper No. w21524. Available at SSRN: https://ssrn.com/abstract=2656907

Emmanuel Farhi (Contact Author)

Harvard University - Department of Economics ( email )

1875 Cambridge Street
Cambridge, MA 02138
United States

National Bureau of Economic Research (NBER) ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Xavier Gabaix

Harvard University - Department of Economics ( email )

Littauer Center
Cambridge, MA 02138
United States

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Centre for Economic Policy Research (CEPR)

London
United Kingdom

European Corporate Governance Institute (ECGI)

c/o ECARES ULB CP 114
B-1050 Brussels
Belgium

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