The Simple Economics of Salience and Taxation

Abstract

This paper derives empirically implementable formulas for the incidence and efficiency costs of taxation that account for tax salience effects as well as other optimization errors. Contrary to conventional wisdom, the formulas imply that the economic incidence of a tax depends on its statutory incidence and that a tax can create deadweight loss even if it induces no change in demand. The results are derived using simple supply and demand diagrams and familiar notions of consumer and producer surplus. The approach to welfare analysis proposed here yields robust formulas because it does not require specification of a positive theory for why agents fail to optimize with respect to tax policies.