Taxing Humans: Pitfalls of the Mechanism Design Approach and Potential Resolutions

Alex Rees-Jones, Dmitry Taubinsky

NBER Working Paper No. 23980
Issued in October 2017
NBER Program(s):Public Economics

A growing body of evidence suggests that psychological biases can lead different implementations of otherwise equivalent tax incentives to result in meaningfully different behaviors. We argue that in the presence of such failures of “implementation invariance,” decoupling the question of optimal feasible allocations from the tax system used to induce them—the “mechanism design approach” to tax analysis—cannot be the right approach to analyzing optimal tax systems. After reviewing the diverse psychologies that lead to failures of implementation invariance, we illustrate our argument by formally deriving three basic lessons that arise in the presence of these biases. First, the mechanism design approach neither estimates nor bounds the welfare computed under psychologically realistic assumptions about individuals' responses to the tax instruments used in practice. Second, the optimal allocations from abstract mechanisms may not be implementable with concrete tax policies, and vice-versa. Third, the integration of these biases may mitigate the importance of information asymmetries, resulting in optimal tax formulas more closely approximated by classical Ramsey results. We conclude by proposing that a “behavioral” extension of the “sufficient statistics” approach is a more fruitful way forward in the presence of such psychological biases.

download in pdf format
   (419 K)

email paper

Machine-readable bibliographic record - MARC, RIS, BibTeX

Document Object Identifier (DOI): 10.3386/w23980

Published: Taxing Humans: Pitfalls of the Mechanism Design Approach and Potential Resolutions, Alex Rees-Jones, Dmitry Taubinsky. in Tax Policy and the Economy, Volume 32, Moffitt. 2018

Users who downloaded this paper also downloaded* these:
Parker and Souleles w23920 Reported Effects vs. Revealed-Preference Estimates: Evidence from the propensity to spend tax rebates
Saez, Schoefer, and Seim w23976 Payroll Taxes, Firm Behavior, and Rent Sharing: Evidence from a Young Workers' Tax Cut in Sweden
Sanders and Sandler w23966 Technology and the Effectiveness of Regulatory Programs Over Time: Vehicle Emissions and Smog Checks with a Changing Fleet
Xiong w18905 Bubbles, Crises, and Heterogeneous Beliefs
Bénabou w14764 Groupthink: Collective Delusions in Organizations and Markets
NBER Videos

National Bureau of Economic Research, 1050 Massachusetts Ave., Cambridge, MA 02138; 617-868-3900; email:

Contact Us