Working Paper: CEPR ID: DP11008
Authors: Emmanuel Farhi; Xavier Gabaix
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.
Keywords: behavioural public finance; inattention; mistakes; nudges
JEL Codes: D03; H21
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| inattention (D91) | optimal taxes (H21) |
| misperceptions of taxes (H26) | modifications in the Ramsey inverse elasticity rule (H21) |
| behavioral biases (D91) | alterations in traditional tax formulas (H29) |
| behavioral biases (D91) | optimal Pigouvian tax adjustments (H23) |
| behavioral biases (D91) | tax efficacy (H26) |
| behavioral interventions (C99) | tax efficiency (H21) |