Schedule Selection by Agents: From Price Plans to Tax Tables

Working Paper: NBER ID: w13808

Authors: Erzo FP Luttmer; Richard J Zeckhauser

Abstract: Requiring agents with private information to select from a menu of incentive schedules can yield efficiency gains. It will do so if, and only if, agents will receive further private information after selecting the incentive schedule but before taking the action that determines where on the incentive schedule they end up. We argue that this information structure is relevant in many applications. We develop the theory underlying optimal menus of non-linear schedules and prove that there exists a menu of schedules that offers a strict first-order interim Pareto improvement over the optimal single non-linear schedule. We quantify the gains from schedule selection in two settings. The first is a stylized example of a monopolistic utility company increasing profits by offering a menu of price plans. The second is a simulation based on U.S. earnings data, which shows that moving to a tax system that allows individuals to choose their tax schedule increases social welfare by the same amount as would occur from a 4.0 percent windfall gain in the government budget (or about $600 per filer per year). The resulting reduction in distortions accounts for about two thirds of the increase in social welfare while the remainder comes from an increase in redistribution.

Keywords: incentive schedules; efficiency gains; social welfare; menu selection

JEL Codes: D42; D82; H21

Causal Claims

Cause	Effect
initial private information (signal) (D82)	probability distribution of the agent's type (D39)
subsequent private information (type) (Y50)	agent's choice on the incentive schedule (C78)
offering a menu of schedules (C78)	strict first-order interim Pareto improvement (D61)
monopolistic utility company offering a menu of price plans (L97)	increase in profits (D33)
allowing individuals to choose from tax schedules (H20)	increase in social welfare (H53)