Working Paper No. 14-33:
Salience and Sin: Designing Taxes in the New Sin Era
Date Posted: August 2014
Abstract (below) | Full text (most recent) on SSRN
Tax salience reflects the extent to which consumers take into account the after-tax cost of a good or service prior to making their consumption decision. Recent empirical work on tax salience has revealed something that is perhaps intuitive, but nevertheless important to the design of sin taxes. Taxpayers are more likely to make consumption decisions based on pre-tax rather than post-tax prices when the salience, or visibility, of a tax is diminished. Thus, consumers are less likely to change their demand for a particular product if shelf prices are tax-exclusive rather than tax-inclusive. Economically, this makes low salience taxes mimic some of the benefits of taxes on inelastically demanded goods. Because a taxpayer’s demand change in response to a tax increase is diminished, the deadweight loss generated by the imposition of the tax can be reduced. Notwithstanding the potential for efficiency gains, politicians and academics alike have expressed various fairness, distributional, and normative concerns regarding the use of low salience taxes. In fact, a number of countries already require tax-inclusive pricing for consumer products in order to purportedly preserve consumer awareness and transparency.
In contrast, I argue that lawmakers should not rush to reject tax-exclusive pricing outright and should continue to explore the benefits of low salience taxes in select situations. To the extent lawmakers are able to minimize economic distortions the concerns that have been expressed are not always fatal. I develop a new analytical rubric for tax salience, and determine that the appropriate use of salience for any particular tax is dependent on a number of factors. These factors include the price elasticity of demand, the potential for countervailing income effects, and whether the tax is intended to raise revenue or modify taxpayer behavior. As a normative matter, I find that selectively implemented low salience taxes can be beneficial. However, I do not believe they should be universally implemented in sin tax design. In fact, in another expansion on the current literature, I argue that in certain situations lawmakers may best benefit from high salience taxes. I propose that these taxes may have efficiency benefits when lawmakers are seeking to influence taxpayer behavior. Ultimately, while it is difficult to draw definitive conclusions regarding the optimal use of tax salience given that many empirical and theoretical aspects of salience have yet to be developed, the empirical work done to-date suggests that the impact of tax salience on tax design may be significant and is worth exploring.