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  3. American Economic Review
  4. January 2020
  5. Optimal Taxation with Behavioral Agents

American Economic Review

ISSN 0002-8282 (Print) | ISSN 1944-7981 (Online)

Optimal Taxation with Behavioral Agents

  • Emmanuel Farhi
  • Xavier Gabaix
American Economic Review
vol. 110, no. 1, January 2020
(pp. 298–336)
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Abstract

This paper develops a theory of optimal taxation with behavioral agents. We use a general framework that encompasses a wide range of biases such as misperceptions and internalities. 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 novel economic insights. We also show how to incorporate nudges in the optimal taxation framework, and jointly characterize optimal taxes and nudges.

Citation

Farhi, Emmanuel, and Xavier Gabaix. 2020. "Optimal Taxation with Behavioral Agents." American Economic Review, 110 (1): 298–336. DOI: 10.1257/aer.20151079

Additional Materials

JEL Classification

  • D62 Externalities
  • D91 Micro-Based Behavioral Economics: Role and Effects of Psychological, Emotional, Social, and Cognitive Factors on Decision Making
  • H21 Taxation and Subsidies: Efficiency; Optimal Taxation