Last Thursday, I had the pleasure of listening to Hunt Alcott, Assistant Professor of Economics at NYU, present some new work on the impact of taxation when consumers are inattentive to certain types of price signals.
Earlier in this course we learned about different types of taxes: corrective taxes that “correct” a market failure and increase social welfare and distortionary taxes that raise revenue, but decrease social welfare. Dr. Alcott and co-authors’ provocative hypothesis is that when consumers make mistakes in thinking about different types of prices, you can construct taxes that are not corrective, but nonetheless increase social welfare. Literally, you are taxing people to make them better off. This is “We’re from the government and we’re here to help” taken up a notch.
To understand this hypothesis we need to define the particular type of mistake that consumers are making. This mistake is what the authors call “inattention.” Drawing on the literature, they argue that people are often more price responsive to purchase prices than to other implicit prices or ancillary costs. For example, people are more responsive to purchase price than shipping and handling costs or sales tax rates. They argue that the long run fuel costs associated with operating a vehicle are similar ancillary costs and consumers may be inattentive to these costs when making their car purchase decision.
Under these circumstances, taxing gas-inefficient vehicles, or implicitly taxing them through a CAFE standard, can actually make inattentive people better off. The tax increases the relative purchase price of the gas-guzzler and decreases the relative purchase price of the fuel-efficient car. The tax distorts relative prices in a way that makes consumers recognize the long-term costs of operating the vehicle (which they would otherwise be inattentive to) by embedding them in the upfront purchase cost. The increase in social welfare from this type of “internality” tax holds even if there are no externalities (carbon emissions etc.) from the burning of the additional gasoline.
To say that taxing people to make them better off is politically infeasible (and undesirable) is an understatement. But the idea that people make mistakes in trading off current costs and longer terms costs is well-established in the literature. It is worth thinking of less paternalistic ways to help people make tradeoffs that ex post, they would agree made them better off. The authors offer four broad categories of such policies all of which try to target the policy to customers most likely to be inattentive. While any of these may work theoretically it is often quite difficult to target customers who are inattentive. How do you tell if a customer is inattentive to gas prices or really just likes trucks?
Full paper: Allcott,Hunt, Sendhil Mullainathan, and Dmitry Taubinsky “Externalizing the Internality“