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Salience and Taxation: Theory and Evidence

  • Raj Chetty
  • Adam Looney
  • Kory Kroft

Using two strategies, we show that consumers underreact to taxes that are not salient. First, using a field experiment in a grocery store, we find that posting tax-inclusive price tags reduces demand by 8 percent. Second, increases in taxes included in posted prices reduce alcohol consumption more than increases in taxes applied at the register. We develop a theoretical framework for applied welfare analysis that accommodates salience effects and other optimization failures. The simple formulas we derive imply that the economic incidence of a tax depends on its statutory incidence, and that even policies that induce no change in behavior can create efficiency losses. (JEL C93, D12, H25, H71)

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Article provided by American Economic Association in its journal American Economic Review.

Volume (Year): 99 (2009)
Issue (Month): 4 (September)
Pages: 1145-77

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Handle: RePEc:aea:aecrev:v:99:y:2009:i:4:p:1145-77
Note: DOI: 10.1257/aer.99.4.1145
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