Seminar

Optimal Taxation with Behavioral Agents

Xavier Gabaix (NYU, CEPR and NBER)

June 8, 2015, 11:00–12:30

Room MS 001

Fédération des Banques Françaises Seminar

Abstract

This paper develops a theory of optimal taxation with behavioral agents. We use a general behavioral framework that encompasses a wide range of behavioral biases such as misperceptions, internalities and mental accounting. We revisit the three pillars of optimal taxation: Ramsey (linear commodity taxation to raise revenues and redistribute), Pigou (linear commodity taxation to correct externalities) and Mirrlees (nonlinear income taxation). We show how the canonical optimal tax formulas are modified and lead to a rich set of novel economic insights. We also show how to incorporate nudges in the optimal taxation frameworks, and jointly characterize optimal taxes and nudges. Under some conditions, the optimal tax system is simple, in the sense that all tax rates are equal. For instance, all goods are optimally taxed at the same rate (or a few different rates), and the optimal income tax features just one marginal tax rate (or a few different marginal tax rates). This contrasts with the traditional optimal tax results, that generically features complex tax systems that depend on the details of the environment. Finally, we explore the Diamond-Mirrlees productive efficiency result and the Atkinson-Stiglitz uniform commodity taxation proposition, and find that they are more likely to fail with behavioral agents.