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Optimal Taxation with Behavioral Agents

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  • Farhi, Emmanuel
  • Gabaix, Xavier

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

  • Farhi, Emmanuel & Gabaix, Xavier, 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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    Cited by:

    1. Alex Rees-Jones & Dmitry Taubinsky, 2016. "Heuristic Perceptions of the Income Tax: Evidence and Implications for Debiasing," NBER Working Papers 22884, National Bureau of Economic Research, Inc.
    2. John Y. Campbell, 2016. "Restoring Rational Choice: The Challenge of Consumer Financial Regulation," American Economic Review, American Economic Association, pages 1-30.
    3. repec:eee:jetheo:v:172:y:2017:i:c:p:163-201 is not listed on IDEAS
    4. Lanz, Bruno & Wurlod, Jules-Daniel & Panzone, Luca & Swanson, Timothy, 2018. "The behavioral effect of Pigovian regulation: Evidence from a field experiment," Journal of Environmental Economics and Management, Elsevier, vol. 87(C), pages 190-205.
    5. Gabaix, Xavier, 2015. "Behavioral Macroeconomics Via Sparse Dynamic Programming," CEPR Discussion Papers 11026, C.E.P.R. Discussion Papers.
    6. König, Tobias & Lausen, Tobias, 2016. "Relative consumption preferences and public provision of private goods," Discussion Papers, Research Unit: Market Behavior SP II 2016-213, Social Science Research Center Berlin (WZB).
    7. Goldin, Jacob, 2015. "Optimal tax salience," Journal of Public Economics, Elsevier, pages 115-123.
    8. Ravi Kanbur & Jukka Pirttilä & Matti Tuomala & Tuuli Ylinen, 2015. "Optimal taxation and public provision for poverty reduction," WIDER Working Paper Series 054, World Institute for Development Economic Research (UNU-WIDER).
    9. Alex Rees-Jones & Dmitry Taubinsky, 2017. "Taxing Humans: Pitfalls of the Mechanism Design Approach and Potential Resolutions," NBER Chapters,in: Tax Policy and the Economy, Volume 32 National Bureau of Economic Research, Inc.
    10. König, Tobias & Lausen, Tobias, 2017. "Relative Consumption Preferences and Public Provision of Private Goods," Rationality and Competition Discussion Paper Series 18, CRC TRR 190 Rationality and Competition.
    11. Gerritsen, Aart, 2016. "Optimal taxation when people do not maximize well-being," Journal of Public Economics, Elsevier, pages 122-139.
    12. Justine S. Hastings & Jesse M. Shapiro, 2017. "How Are SNAP Benefits Spent? Evidence from a Retail Panel," NBER Working Papers 23112, National Bureau of Economic Research, Inc.
    13. Garth Heutel, 2017. "Prospect Theory and Energy Efficiency," NBER Working Papers 23692, National Bureau of Economic Research, Inc.
    14. Felix Bierbrauer, 2016. "Effizienz oder Gerechtigkeit? Ungleiche Einkommen, ungleiche Vermögen und die Theorie der optimalen Besteuerung," Discussion Paper Series of the Max Planck Institute for Research on Collective Goods 2016_03, Max Planck Institute for Research on Collective Goods.

    More about this item

    Keywords

    behavioural public finance; inattention; mistakes; nudges;

    JEL classification:

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

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