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Optimal Taxation with Behavioral Agents

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  • Gabaix, Xavier
  • Farhi, Emmanuel

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.

Suggested Citation

  • Gabaix, Xavier & Farhi, Emmanuel, 2015. "Optimal Taxation with Behavioral Agents," CEPR Discussion Papers 11008, C.E.P.R. Discussion Papers.
    • Handle: RePEc:cpr:ceprdp:11008
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    More about this item

    Keywords

    Behavioural public finance; Inattention; Mistakes; Nudges;
    All these keywords.

    JEL classification:

    • D03 - Microeconomics - - General - - - Behavioral Microeconomics: Underlying Principles
    • H21 - Public Economics - - Taxation, Subsidies, and Revenue - - - Efficiency; Optimal Taxation

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