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Policy Implications of Suboptimal Choice: Theory and Evidence

Paper Session

Saturday, Jan. 6, 2018 2:30 PM - 4:30 PM

Pennsylvania Convention Center, 105-A
Hosted By: American Economic Association
  • Chair: Dmitry Taubinsky, University of California-Berkeley

Tax Audits as Scarecrows: Evidence from a Large-Scale Field Experiment

Marcelo Bergolo
,
University of the Republic
Rodrigo Ceni
,
University of the Republic
Guillermo Cruces
,
National University of La Plata
Matías Giaccobasso
,
University of the Republic
Ricardo Perez-Truglia
,
University of California-Los Angeles

Abstract

According to the canonical model of Allingham and Sandmo (1972), firms evade taxes by making a trade-off between a lower tax burden and higher expected penalties. However, there is still no consensus about whether real-world firms operate in this rational way. We conducted a large-scale field experiment, sending letters to over 20,000 firms that collectively pay over 200 million dollars in taxes per year. In our letters, we provided firms with exogenous but nondeceptive signals about key inputs for their evasion decisions, such as audit probabilities and penalty rates. We measure the effect of these signals on their subsequent perceptions about the auditing process, based on survey data, as well as on the actual taxes paid, according to administrative data. We find that firms do increase their tax compliance in response to information about audits. However, the patterns in these responses are inconsistent with utility maximization. The evidence suggests that, much like scarecrows frighten off birds, audits can be a significant deterrent for tax evaders even though they would be perceived as harmless by a rational optimizer.

Ramsey strikes back: Optimal commodity taxes and redistribution in the presence of salience effects

Hunt Allcott
,
New York University
Dmitry Taubinsky
,
University of California-Berkeley
Benjamin B. Lockwood
,
University of Pennsylvania

Abstract

An influential result in modern optimal tax theory, the Atkinson and Stiglitz (1976) theorem, holds that for a broad class of utility functions, all redistribution should be carried out through labor income taxation, rather than differential taxes on commodities or capital. An important requirement for that result is that commodity taxes are known and fully salient when consumers make income-determining choices. This paper allows for the possibility consumers may be inattentive to (or unaware of) some commodity taxes when making choices about income. We show that commodity taxes are useful for redistribution in this setting. In fact, the optimal commodity taxes follow the classic “many person Ramsey rule” (Diamond, 1975), scaled by the degree of inattention. As a result, to the extent that commodity taxes are not (fully) salient, goods should be taxed when they are less elastically consumed, and when they are consumed primarily by richer consumers. We extend this result to the setting of corrective taxes, and show how nonsalient corrective taxes should be adjusted for distributional reasons.

Borrowing to Save? The Impact of Automatic Enrollment on Debt

John Beshears
,
Harvard Business School
James Choi
,
Yale University
David Laibson
,
Harvard University
Brigitte Madrian
,
Harvard University
William Skimmyhorn
,
United States Military Academy

Abstract

How much of the retirement savings induced by automatic enrollment is offset by increased borrowing outside the retirement savings plan? We study a natural experiment created when the U.S. Army began automatically enrolling its newly hired civilian employees into the Thrift Savings Plan (TSP) at a default contribution rate of 3% of income. We find that four years after hire, as a percent of first-year annualized salary, automatic enrollment raises cumulative employer plus employee TSP contributions by 5.7% on average. However, automatic enrollment’s effect on wealth net of debt is only 3.5% of first-year salary on average, representing a 38% crowd-out. We cannot reject the hypothesis that all of the increase in employee contributions induced by automatic enrollment is financed by debt, and that saving increases only because of the employer match.

Optimal Defaults with Normative Ambiguity

Jacob Goldin
,
Stanford University
Daniel Reck
,
London School of Economics

Abstract

A large and growing literature suggests that decision-makers are more likely to select options presented to them as the default. Numerous decision-making models can potentially explain the presence of default effects. However, such models differ in their implications for the link between choices and welfare, and are difficult to distinguish empirically. In this paper, we study how alternative explanations for default effects shape conclusions about optimal policy. We utilize a simple and general framework that nests most models of default effects that have been described in the literature. The model parameterizes the degree to which default effects arise due to a welfare-relevant preference versus a mistake on the part of decision-makers. When this parameter is unknown – a situation we refer to as normative ambiguity – determining the optimal default is often impossible. We apply this framework to data on 401(k) plan contributions and find that the optimal policy is to promote active choices when less than 6 to 9 percent of employees’ revealed opt-out costs (about $120 to $180) are welfare-relevant, and otherwise to minimize opt-outs.

Paternalism and Pseudo-rationality

Itzik Fadlon
,
University of California-San Diego
David Laibson
,
Harvard University

Abstract

Resource allocations are jointly determined by the actions of social planners and households. In this paper we highlight the distinction between planner optimization and household optimization. We show that planner optimization is a substitute for household optimization and that this is true even when there are information asymmetries, so that households know more about their preferences than planners. Our analysis illustrates the scope for misattribution in economic analysis. Are seemingly optimal allocations caused by optimizing households, or are such allocations caused by planners who paternalistically influence myopic and passive households? We show that widely studied allocative optimality conditions that are implied by household optimization also arise in an economy with a rational planner who uses default savings and Social Security to influence the choices of non-optimizing households. Many classical optimization conditions do not resolve the question of household optimization. Pseudo-rationality arises when rational planners elicit approximately optimal behavior from non-optimizing households.
Discussant(s)
Judd Benjamin Kessler
,
University of Pennsylvania
Benjamin B. Lockwood
,
University of Pennsylvania
Jacob Goldin
,
Stanford University
Alex Rees-Jones
,
University of Pennsylvania
Keith Ericson
,
Boston University
JEL Classifications
  • H0 - General
  • D6 - Welfare Economics