NATIONAL BUREAU OF ECONOMIC RESEARCH
NATIONAL BUREAU OF ECONOMIC RESEARCH
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Optimal Taxation with Behavioral Agents

Emmanuel Farhi, Xavier Gabaix

NBER Working Paper No. 21524
Issued in September 2015, Revised in August 2019
NBER Program(s):Economic Fluctuations and Growth Program, Public Economics Program

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.

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Document Object Identifier (DOI): 10.3386/w21524

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