Journal Article

Attention Variation and Welfare: Theory and Evidence from a Tax Salience Experiment

Dmitry Taubinsky and Alex Rees-Jones

in The Review of Economic Studies

Volume 85, issue 4, pages 2462-2496
Published in print October 2018 | ISSN: 0034-6527
Published online November 2017 | e-ISSN: 1467-937X | DOI: https://dx.doi.org/10.1093/restud/rdx069
Attention Variation and Welfare: Theory and Evidence from a Tax Salience Experiment

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  • Design of Experiments
  • Microeconomics
  • Public Economics

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Abstract

This article shows that accounting for variation in mistakes can be crucial for welfare analysis. Focusing on consumer under-reaction to not-fully-salient sales taxes, we show theoretically that the efficiency costs of taxation are amplified by differences in under-reaction across individuals and across tax rates. To empirically assess the importance of these issues, we implement an online shopping experiment in which 2,998 consumers purchase common household products, facing tax rates that vary in size and salience. We replicate prior findings that, on average, consumers under-react to non-salient sales taxes—consumers in our study react to existing sales taxes as if they were only 25% of their size. However, we find significant individual differences in this under-reaction, and accounting for this heterogeneity increases the efficiency cost of taxation estimates by at least 200%. Tripling existing sales tax rates nearly doubles consumers’ attention to taxes, and accounting for this endogeneity increases efficiency cost estimates by 336%. Our results provide new insights into the mechanisms and determinants of boundedly rational processing of not-fully-salient incentives, and our general approach provides a framework for robust behavioural welfare analysis.

Keywords: Tax salience; Rational inattention; Deadweight loss; Welfare analysis; C9; D0; H0

Journal Article.  19452 words.  Illustrated.

Subjects: Design of Experiments ; Microeconomics ; Public Economics

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