Correct Me If You Can - Optimal Non-Linear Taxation of Internalities

40 Pages Posted: 25 Jul 2019

See all articles by Andreas Gerster

Andreas Gerster

University of Mannheim

Michael Kramm

University of Dortmund - Ruhr Graduate School in Economics; Technical University of Dortmund

Date Written: 2019

Abstract

A growing literature has shown that behavioral biases influence consumer choices. Such so-called internalities are ubiquitous in many settings, including energy efficiency investments and the consumption of sin goods, such as cigarettes and sugar. In this paper, we use a mechanism design approach to characterize the optimal non-linear tax (or subsidy) for correcting behaviorally biased consumers. We demonstrate that market choices are informative about consumers' bias, which can be exploited for benevolent price discrimination via a non-linear tax schedule. We derive that such "internality revelation" depends on two sufficient statistics: the correlation between valuations and biases, as well as the signal-to-noise ratio of the bias. Furthermore, we find that there must be a minimum alignment of preferences among the designer and the consumer to ensure internality tax implementability. We contrast our results with the insights from standard non-linear income taxation and discuss that the optimal corrective tax schedule is typically convex. In addition, we apply our findings to the light bulb market and determine the optimal non-linear subsidy for energy efficiency.

Keywords: optimal commodity taxation, non-linear taxation, behavioral economics, public economics, internalities, environmental economics

JEL Classification: H210, D820, D040, Q580

Suggested Citation

Gerster, Andreas and Kramm, Michael, Correct Me If You Can - Optimal Non-Linear Taxation of Internalities (2019). CESifo Working Paper No. 7732. Available at SSRN: https://ssrn.com/abstract=3422627

Andreas Gerster (Contact Author)

University of Mannheim ( email )

Universitaetsbibliothek Mannheim
Zeitschriftenabteilung
Mannheim, 68131
Germany

Michael Kramm

University of Dortmund - Ruhr Graduate School in Economics ( email )

Hohenzollernstr. 1-3
Essen, NRW 45128
Germany

Technical University of Dortmund ( email )

Emil-Figge-Stra├če 50
Dortmund, 44227
Germany

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