TaxProf Blog

Editor: Paul L. Caron, Dean
Pepperdine University School of Law

Tuesday, June 25, 2013

Taxes and Mistakes

Daniel H. Reck (University of Michigan, Department of Economics), Taxes and Mistakes: What's in a Sufficient Statistic?:

This paper develops a model of mistakes in tax perception to understand how different behavioral assumptions about the nature of mistakes have different welfare implications; using an approach developed by Chetty, Looney, and Kroft (2009). Specifically, it examines the importance of assumptions about bounded rationality, cognitive costs, budget adjustment rules, and the origin of mis-perceptions. Bounded rationality -- defined here as a tendency to "de-bias" when the stakes are sufficiently high -- will cause the statistics of the CLK Model to depend on the fraction of optimizing agents and the gain to de-biasing. Attempts to exploit mis-perception to reduce excess burden, say by shifting from high to low salience taxes, can actually increase excess burden on the margin, due to the "curse of de-biasing." When de-biasing incurs cognitive costs, this problem is exacerbated. Budget adjustment rules matter as much as mis-perception of marginal prices, so studies which only detect that individuals ignore taxes or mis-perceive tax rates tell us little about welfare, unless they also assume or estimate a budget adjustment rule. The paper also shows how this model applies to mis-perceptions other than inattention using the example of what Liebman and Zeckhauser (2004) call "ironing" -- the confusion of average and marginal tax rates -- and provides a comment on the welfare analysis of Liebman and Zeckhauser.

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