Rules of Thumb and Attention Elasticities: Evidence from Under- and Overreaction to Taxes

This paper tests costly attention models of consumers’ misreaction to opaque taxes. We report an online shopping experiment that involves shrouded sales taxes that are exogenously varied within consumer over time. Some consumers systematically underreact to sales taxes while others systematically overreact, but higher stakes decrease both under- and overreaction. This is consistent with consumers using heterogeneous rules of thumb to compute the opaque tax when the stakes are low, but using costly mental effort at higher stakes. The results allow us to differentiate between various theories of limited attention. We also develop novel econometric techniques for quantifying individual differences.