Conferences at Department of Economics, University of Toronto, Canadian Economic Theory Conference 2015

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Optimal Taxation with Non-sophisticated Agents

Pei Cheng Yu*

Date: 2015-05-09 10:15 am – 10:45 am
Last modified: 2015-05-04

Abstract


This paper studies a model of taxation where the government faces non-sophisticated agents with private information on productivity. Non-sophisticated agents (also known as partially naive agents) are not fully aware of impending changes in their preferences, in contrast to sophisticated agents who can fully forecast their future preference changes. In particular, this paper addresses the problem of inadequate savings resulting from time inconsistent individuals who are partially aware of their present bias. I demonstrate how the government can design an optimal truth-telling incentive scheme to achieve any redistribution outcome despite information asymmetry. In other words, the private information on productivity does not impede the government from implementing the first best allocation. This result holds under very general conditions with agents who have imperfect forecasting abilities, and can be implemented using income specific non-linear savings subsidies. As extensions, I examine other environments where this result would not hold and asymmetric information would distort the set of implementable allocations. This includes economies with diversely naive agents, when the degree of non-sophistication is uncertain, and settings with restrictions on the tax instruments.

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