Abstract
Using two strategies, we show that consumers underreact to taxes that are not salient. First, using a field experiment in a grocery store, we find that posting tax-inclusive price tags reduces demand by 8 percent. Second, increases in taxes included in posted prices reduce alcohol consumption more than increases in taxes applied at the register. We develop a theoretical framework for applied welfare analysis that accommodates salience effects and other optimization failures. The simple formulas we derive imply that the economic incidence of a tax depends on its statutory incidence, and that even policies that induce no change in behavior can create efficiency losses. (JEL C93, D12, H25, H71)
Highlights
A central assumption in public ...nance is that agents optimize fully with respect to taxes.For example, Ramsey’s (1927) seminal analysis of optimal commodity taxation assumes that agents respond to tax changes in the same way that they respond to price changes
We focus on alcohol consumption, because alcohol is subject to two state-level taxes in the U.S.: an excise tax that is included in the posted price and a sales tax that is added at the register
The evidence above indicates that behavioral responses to commodity taxation depend substantially on whether taxes are included in posted prices
Summary
A central assumption in public ...nance is that agents optimize fully with respect to taxes. Ramsey’s (1927) seminal analysis of optimal commodity taxation assumes that agents respond to tax changes in the same way that they respond to price changes. Models of optimal income taxation assume that agents choose labor supply and consumption optimally irrespective of the complexity of the tax schedule they face (e.g. Mirrlees 1971, Atkinson and Stiglitz 1976). Similar assumptions are implicit in positive analyses of taxation and empirical studies of behavioral responses to taxation. Income tax schedules are typically highly non-linear, bene...t-tax linkages for social insurance programs are opaque (e.g. social security taxes and bene...ts), and taxes on commodities vary and are often not directly displayed in posted prices (sales taxes, hotel city taxes, vehicle excise fees). Classic results on tax incidence and e¢ ciency costs (e.g. Harberger 1964) rely on full optimization with respect to such tax policies
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