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Attention Variation and Welfare: Theory and Evidence from a Tax Salience Experiment

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  • Dmitry Taubinsky
  • Alex Rees-Jones

Abstract

This paper shows that accounting for variation in mistakes can be crucial for welfare analysis. Focusing on consumer underreaction to not-fully-salient sales taxes, we show theoretically that the efficiency costs of taxation are amplified by differences in underreaction across individuals and across tax rates. To empirically assess the importance of these issues, we implement an online shopping experiment in which 2,998 consumers purchase common household products, facing tax rates that vary in size and salience. We replicate prior findings that, on average, consumers underreact to non-salient sales taxes—consumers in our study react to existing sales taxes as if they were only 25% of their size. However, we find significant individual differences in this underreaction, and accounting for this heterogeneity increases the efficiency cost of taxation estimates by at least 200%. Tripling existing sales tax rates nearly doubles consumers’ attention to taxes, and accounting for this endogeneity increases efficiency cost estimates by 336%. Our results provide new insights into the mechanisms and determinants of boundedly rational processing of not-fully-salient incentives, and our general approach provides a framework for robust behavioral welfare analysis.

Suggested Citation

  • Dmitry Taubinsky & Alex Rees-Jones, 2016. "Attention Variation and Welfare: Theory and Evidence from a Tax Salience Experiment," NBER Working Papers 22545, National Bureau of Economic Research, Inc.
  • Handle: RePEc:nbr:nberwo:22545
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    More about this item

    JEL classification:

    • C9 - Mathematical and Quantitative Methods - - Design of Experiments
    • D0 - Microeconomics - - General
    • H0 - Public Economics - - General

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