The Simple Economics of Salience and Taxation
This paper derives empirically implementable formulas for the incidence and efficiency costs of taxation that account for tax salience effects as well as other optimization errors. Contrary to conventional wisdom, the formulas imply that the economic incidence of a tax depends on its statutory incidence and that a tax can create deadweight loss even if it induces no change in demand. The results are derived using simple supply and demand diagrams and familiar notions of consumer and producer surplus. The approach to welfare analysis proposed here yields robust formulas because it does not require specification of a positive theory for why agents fail to optimize with respect to tax policies.
Thanks to George Akerlof, Alan Auerbach, Douglas Bernheim, Peter Diamond, Caroline Hoxby, Kory Kroft, Botond Koszegi, Adam Looney, Erzo Luttmer, Matthew Rabin, and numerous seminar participants for helpful comments and discussions. Gregory Bruich, Robert C. Parker, and Ity Shurtz provided outstanding research assistance. Funding was provided by NSF grant SES 0452605. The views expressed herein are those of the author(s) and do not necessarily reflect the views of the National Bureau of Economic Research.