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Salience and taxation: theory and evidence

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Author Info
Raj Chetty
Adam Looney
Kory Kroft

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Abstract

This paper presents evidence that consumers underreact to taxes that are not salient and characterizes the welfare consequences of tax policies when agents make such optimization errors. The empirical evidence is based on two complementary strategies. First, we conducted an experiment at a grocery store posting tax inclusive prices for 750 products subject to sales tax for a three week period. Scanner data show that this intervention reduced demand for the treated products by 8 percent. Second, we find that state-level increases in excise taxes (which are included in posted prices) reduce alcohol consumption significantly more than increases in sales taxes (which are added at the register and are hence less salient). We develop simple, empirically implementable formulas for the incidence and efficiency costs of taxation that account for salience effects as well as other optimization errors. Contrary to conventional wisdom, the formulas imply that the economic incidence of a tax depends on its statutory incidence and that a tax can create deadweight loss even if it induces no change in demand. Our method of welfare analysis yields robust results because it does not require specification of a positive theory for why agents fail to optimize with respect to tax policies.

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Paper provided by Board of Governors of the Federal Reserve System (U.S.) in its series Finance and Economics Discussion Series with number 2009-11.

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Date of creation: 2009
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Handle: RePEc:fip:fedgfe:2009-11

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Keywords: Taxation ; Consumer behavior;

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Full references

Cited by:
(explanations, Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.)

  1. Kristin Kiesel & Sofia Villas-Boas, 2008. "Another Nutritional Label--Experimenting with Grocery Store Shelf Labels and Consumer Choice--," Department of Agricultural & Resource Economics, UC Berkeley, Working Paper Series 1060, Department of Agricultural & Resource Economics, UC Berkeley. [Downloadable!]
  2. Rupert Sausgruber & Jean-Robert Tyran, 2008. "Tax Salience, Voting, and Deliberation," Discussion Papers 08-21, University of Copenhagen. Department of Economics. [Downloadable!]
  3. Raj Chetty & Adam Looney & Kory Kroft, 2009. "Salience and taxation: theory and evidence," Finance and Economics Discussion Series 2009-11, Board of Governors of the Federal Reserve System (U.S.). [Downloadable!]
    Other versions:
  4. Gallagher, Kelly Sims & Muehlegger, Erich, 2008. "Giving Green to Get Green: Incentives and Consumer Adoption of Hybrid Vehicle Technology," Working Paper Series rwp08-009, Harvard University, John F. Kennedy School of Government. [Downloadable!]
  5. Jon Bakija & Bradley Heim, 2008. "How Does Charitable Giving Respond to Incentives and Income? Dynamic Panel Estimates Accounting for Predictable Changes in Taxation," NBER Working Papers 14237, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  6. Gilbert Metcalf & David Weisbach, 2008. "The Design of a Carbon Tax," Discussion Papers Series, Department of Economics, Tufts University 0727, Department of Economics, Tufts University. [Downloadable!]
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  7. Hui Shan, 2008. "Property taxes and elderly mobility," Finance and Economics Discussion Series 2008-50, Board of Governors of the Federal Reserve System (U.S.). [Downloadable!]
  8. Raj Chetty, 2009. "The Simple Economics of Salience and Taxation," NBER Working Papers 15246, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  9. B. Douglas Bernheim & Antonio Rangel, 2008. "Beyond Revealed Preference: Choice Theoretic Foundations for Behavioral Welfare Economics," NBER Working Papers 13737, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  10. Michael D. Grubb & Paul Oyer, 2008. "Who Benefits from Tax-Advantaged Employee Benefits?: Evidence from University Parking," NBER Working Papers 14062, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  11. B. Douglas Bernheim, 2008. "On the Potential of Neuroeconomics: A Critical (but Hopeful) Appraisal," NBER Working Papers 13954, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  12. Marion, Justin & Muehlegger, Erich, 2007. "Measuring Illegal Activity and the Effects of Regulatory Innovation: A Study of Diesel Fuel Tax Evasion," Working Paper Series rwp07-026, Harvard University, John F. Kennedy School of Government. [Downloadable!]
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