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Tax Salience - Salience and Taxation Theory and Evidence...

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Salience and Taxation: Theory and Evidence Raj Chetty Adam Looney Kory Kroft UC-Berkeley and NBER Federal Reserve Board UC-Berkeley August 2008 ° Abstract This paper presents evidence that consumers underreact to taxes that are not salient and characterizes the welfare consequences of tax policies when agents make such op- timization errors. The empirical evidence is based on two complementary strategies. First, we conducted an experiment at a grocery store posting tax inclusive prices for 750 products subject to sales tax for a three week period. Scanner data show that this intervention reduced demand for the treated products by 8 percent . Second, we °nd that state-level increases in excise taxes (which are included in posted prices) re- duce alcohol consumption signi°cantly more than increases in sales taxes (which are added at the register and are hence less salient). We develop simple, empirically im- plementable formulas for the incidence and e¢ ciency costs of taxation that account for salience e/ects as well as other optimization errors. Contrary to conventional wis- dom, 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. Our method of welfare analysis yields robust results because it does not require speci°cation of a positive theory for why agents fail to optimize with respect to tax policies. ° E-mail: [email protected], [email protected], [email protected] We are very grate- ful to So°a Berto Villas-Boas and Reed Johnson for help in implementing the experiment and to Christopher Carpenter, Je/rey Miron, and Lina Tetelbaum for sharing data on alcohol regulations. Thanks to George Akerlof, David Ahn, Alan Auerbach, Douglas Bernheim, Kitt Carpenter, Judith Chevalier, Stefano DellaVi- gna, Amy Finkelstein, Michael Greenstone, Caroline Hoxby, Shachar Kariv, Peter Katuscak, Botond Koszegi, Erzo Luttmer, James Poterba, Matthew Rabin, Ricardo Reis, Emmanuel Saez, Jesse Shapiro, Andrei Shleifer, Dan Sichel, Uri Simonsohn, anonymous referees, and numerous seminar participants for helpful comments and discussions. Laurel Beck, Gregory Bruich, Matt Grandy, Matt Levy, Ankur Patel, Ity Shurtz, James Sly, and Philippe Wingender provided outstanding research assistance. Funding was provided by NSF grant SES 0452605 and the Hoover Institution. The analysis and conclusions set forth are those of the authors and do not indicate concurrence by other members of the research sta/ or the Board of Governors of the Federal Reserve. Appendices and stata code for the empirical analysis are available on Chetty±s website.
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A central assumption in public economics is that agents optimize fully with respect to tax policies. For example, Frank P. Ramsey°s (1927) seminal analysis of optimal commodity taxation assumes that agents respond to tax changes in the same way as price changes.
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