Studying Optimal Paternalism, Illustrated by a Model of Sin Taxes

Abstract

The classical economic approach to policy analysis assumes that people always respond optimally to the costs and benefits of their available choices. A great deal of evidence suggests, however, that in some contexts people make errors that lead them not to behave in their own best interests. Economic policy prescriptions might change once we recognize that humans are humanly rational rather than superhumanly rational, and in particular it may be fruitful for economists to study the possible advantages of paternalistic policies that help people make better choices. We propose an approach for studying optimal paternalism that follows naturally from standard assumptions and methods of economic theory: Write down assumptions about the distribution of rational and irrational types of agents, about the available policy instruments, and about the government’s information about agents, and then investigate which policies achieve the most efficient outcomes. In other words, economists ought to treat the analysis of optimal paternalism as a mechanism-design problem when some agents might be boundedly rational. This approach has many advantages. First and foremost, by explicitly addressing when and how people do and don’t pursue their own best interests, economists will be better able to contribute to policy debates. To contribute to debates over regulating private financial decisions, we must study whether financial decisions are based on fallacious statistical reasoning and whether self-control problems lead people to borrow too heavily; to contribute to debates over teenage smoking, we must study whether teenagers become smokers against their long-run best interest. Economists will and should be ignored if we continue to insist that it is axiomatic that constantly trading stocks or accumulating consumer debt or becoming a heroin addict must be optimal for the people doing these things merely because they have chosen to do it. A second advantage of our approach is that it forces us to look for the best feasible policy. Our