Schedule Selection by Agents: from Price Plans to Tax Tables
Requiring agents with private information to select from a menu of incentive schedules can yield efficiency gains. It will do so if, and only if, agents will receive further private information after selecting the incentive schedule but before taking the action that determines where on the incentive schedule they end up. We argue that this information structure is relevant in many applications. We develop the theory underlying optimal menus of non-linear schedules and prove that there exists a menu of schedules that offers a strict first-order interim Pareto improvement over the optimal single non-linear schedule. We quantify the gains from schedule selection in two settings. The first is a stylized example of a monopolistic utility company increasing profits by offering a menu of price plans. The second is a simulation based on U.S. earnings data, which shows that moving to a tax system that allows individuals to choose their tax schedule increases social welfare by the same amount as would occur from a 4.0 percent windfall gain in the government budget (or about $600 per filer per year). The resulting reduction in distortions accounts for about two thirds of the increase in social welfare while the remainder comes from an increase in redistribution.
We would like to thank Chris Avery, Jerry Green, Michael Grubb, Daniel Hojman, Nolan Miller, Eugenio Miravete and seminar participants at Cornell, Harvard, and Michigan for helpful conversations and insightful comments. Erzo Luttmer gratefully acknowledges funding from the National Institute on Aging through Grant Number T32-AG00186 to the National Bureau of Economic Research. All errors are our own. The views expressed herein are those of the author(s) and do not necessarily reflect the views of the National Bureau of Economic Research.