TY - JOUR AU - Rees-Jones, Alex AU - Taubinsky, Dmitry TI - Taxing Humans: Pitfalls of the Mechanism Design Approach and Potential Resolutions JF - National Bureau of Economic Research Working Paper Series VL - No. 23980 PY - 2017 Y2 - October 2017 DO - 10.3386/w23980 UR - http://www.nber.org/papers/w23980 L1 - http://www.nber.org/papers/w23980.pdf N1 - Author contact info: Alex Rees-Jones University of Pennsylvania The Wharton School Department of Business Economics and Public Policy 3rd Floor, Vance Hall 3733 Spruce Street Philadelphia, PA 19104-6372 E-Mail: alre@wharton.upenn.edu Dmitry Taubinsky University of California, Berkeley Department of Economics 530 Evans Hall #3880 Berkeley, CA 94720-3880 E-Mail: dmitry.taubinsky@berkeley.edu M1 - published as Alex Rees-Jones, Dmitry Taubinsky. "Taxing Humans: Pitfalls of the Mechanism Design Approach and Potential Resolutions," in Robert A. Moffitt, editor, "Tax Policy and the Economy, Volume 32" University of Chicago Press (2018) M3 - presented at "Tax Policy and the Economy", September 14, 2017 AB - A growing body of evidence suggests that psychological biases can lead different implementations of otherwise equivalent tax incentives to result in meaningfully different behaviors. We argue that in the presence of such failures of “implementation invariance,” decoupling the question of optimal feasible allocations from the tax system used to induce them—the “mechanism design approach” to tax analysis—cannot be the right approach to analyzing optimal tax systems. After reviewing the diverse psychologies that lead to failures of implementation invariance, we illustrate our argument by formally deriving three basic lessons that arise in the presence of these biases. First, the mechanism design approach neither estimates nor bounds the welfare computed under psychologically realistic assumptions about individuals' responses to the tax instruments used in practice. Second, the optimal allocations from abstract mechanisms may not be implementable with concrete tax policies, and vice-versa. Third, the integration of these biases may mitigate the importance of information asymmetries, resulting in optimal tax formulas more closely approximated by classical Ramsey results. We conclude by proposing that a “behavioral” extension of the “sufficient statistics” approach is a more fruitful way forward in the presence of such psychological biases. ER -