Behavioral Public Economics The merger of Behavioral Economics and Public Economics has required the

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  • NBER WORKING PAPER SERIES

    BEHAVIORAL PUBLIC ECONOMICS

    B. Douglas Bernheim Dmitry Taubinsky

    Working Paper 24828 http://www.nber.org/papers/w24828

    NATIONAL BUREAU OF ECONOMIC RESEARCH 1050 Massachusetts Avenue

    Cambridge, MA 02138 July 2018

    This chapter is forthcoming in B. Douglas Bernheim, Stefano DellaVigna, and David Laibson (eds.), Handbook of Behavioral Economics, Volume 1, New York: Elsevier. In preparing this chapter, we have benefitted from the thoughtful and insightful comments we received from a number of individuals, including Hunt Allcott, Sandro Ambuehl, Stefano DellaVigna, David Laibson, Benjamin B. Lockwood, and Juan Rios Rivera as well as seminar participants at the Stanford Institute for Theoretical Economics and UC Berkeley. William Morrison and Josh Kim have provided excellent research assistance. Taubinsky thanks the Sloan Foundation for support. The views expressed herein are those of the authors and do not necessarily reflect the views of the National Bureau of Economic Research.

    NBER working papers are circulated for discussion and comment purposes. They have not been peer-reviewed or been subject to the review by the NBER Board of Directors that accompanies official NBER publications.

    © 2018 by B. Douglas Bernheim and Dmitry Taubinsky. All rights reserved. Short sections of text, not to exceed two paragraphs, may be quoted without explicit permission provided that full credit, including © notice, is given to the source.

  • Behavioral Public Economics B. Douglas Bernheim and Dmitry Taubinsky NBER Working Paper No. 24828 July 2018 JEL No. H0

    ABSTRACT

    This chapter surveys work in behavioral public economics, emphasizing the normative implications of non-standard decision making for the design of welfare-improving and/or optimal policies. We highlight combinations of theoretical and empirical approaches that together can produce robust qualitative and quantitative prescriptions for optimal policy under a range of assumptions concerning consumer behavior. The chapter proceeds in four parts. First, we discuss the foundations and methods of behavioral welfare economics, focusing on choice-oriented approaches and the measurement of self-reported well-being. Second, we examine commodity taxes and related policies: we summarize research on optimal corrective taxes, the efficiency costs of sales taxes that are not fully salient, the distributional effects of sin taxes, the use of non- price policies such as nudges, the tax treatment of giving, and luxury taxes. Third, we examine policies affecting saving, including capital income taxation, commitment opportunities, default contribution provisions for pension plans, financial education, and mandatory saving programs. Fourth, we detail the manner in which under-provision of labor supply and misunderstandings of policy instruments impact optimal labor income taxation and social insurance. We close with some recommendations for future work in behavioral public economics.

    B. Douglas Bernheim Department of Economics Stanford University Stanford, CA 94305-6072 and NBER bernheim@stanford.edu

    Dmitry Taubinsky University of California, Berkeley Department of Economics 530 Evans Hall #3880 Berkeley, CA 94720-3880 and NBER dmitry.taubinsky@berkeley.edu

  • 1 Introduction

    The standard economic approach to policy evaluation relies on the assumption of rational �revealed

    preferences,� which holds that people always choose what is best for them, that their choices do not

    depend on seemingly inconsequential �frames,� and that the preferences revealed by their choices

    are transitive and complete. This assumption may seem stringent from a psychological perspective.

    Nevertheless, it is at the heart of modern Public Economics because it directly connects theory

    and data. Within the rational choice paradigm, economists can often quantify the welfare e�ects

    of policies involving commodity taxes, income taxes, unemployment insurance bene�ts, and savings

    incentives using only a few measurable, high-level statistics, such as the elasticity of consumption

    or labor with respect to the tax rate. In a �eld often concerned with quantitative evaluation of

    real-world policies, revealed preferences is a powerful and seemingly crucial identifying assumption.

    Even so, the ostensible purpose of many important public policies is to address the concern that

    people do not always choose what is best for them, and that the determinants of consumer behavior

    extend beyond narrow self-interested optimization. For example, many countries have established

    government bureaus that o�er �consumer protection� to guard against the possibility that �rms may

    attempt to exploit unsophisticated buyers.1 A number of countries have also created �behavioral

    insights� teams, the role of which is to leverage �ndings from psychology and Behavioral Economics

    to formulate more e�ective government policies.2 Policy makers often justify otherwise standard

    policies such as �sin taxes� on cigarettes, alcohol, sugary drinks, and similar goods on the grounds

    that they discourage harmful behaviors. Motivations for consumer-facing energy policy include

    the possibility that people may undervalue energy-e�cient goods and overvalue energy-ine�cient

    ones due to a �defective telescopic faculty� (Hausman, 1979). Arguments for mandatory retirement

    savings programs often reference consumer myopia (Feldstein and Liebman, 2002).

    The existence of such policies, combined with a large and growing body of empirical work in Be-

    havioral Economics, suggests that the standard approach in Public Economics to policy evaluation

    may yield misleading conclusions about the welfare e�ects of some policies, and are simply inappli-

    cable to other policies that in�uence behavior through framing e�ects, such as those that determine

    salience. The rapidly expanding literature in �Behavioral Public Economics� (henceforth BPE)

    combines the methods and insights from Behavioral Economics and Public Economics to extend

    the public-economics toolbox, thereby allowing for more robust evaluations of real-world policies,

    to develop innovative policy tools, and to explain why consumers' responses to policy incentives are

    sometimes anomalous (Chetty, 2015).

    This handbook chapter summarizes the emerging �eld of BPE. A comparison with Bernheim

    and Rangel (2007), which assessed the state of the nascent �eld roughly a dozen years ago, reveals

    that progress has been dramatic. Our focus is on the normative questions that have historically

    1Examples include the Consumer Financial Protection Bureau in the U.S., the Federal Ministry of Justice and Consumer Protection in Germany, the Competition and Consumer Commission in Australia, and the Financial Conduct Authority in the U.K. See the OECD 2017 report for a summary of over 100 applications of �behavioral insights� by government bureaus and sectors across the world.

    2As of the writing of this chapter, such countries include the U.K., U.S., Australia, and Singapore.

    2

  • played central roles in the �eld of Public Economics; we are not primarily concerned with research

    that only aims to describe the positive e�ects of government policies. There are at least two ways

    to organize such a chapter: we could focus on substantive policies, considering relevant behavioral

    phenomena in each instance, or on behavioral phenomena, describing the various policy implications

    in each instance. Consistent with our substantive focus, we adopt the �rst of these approaches. The

    challenge for BPE that we seek to highlight throughout this chapter is the need to maintain the

    tight link between empirically measurable statistics and welfare estimates, while moving beyond the

    revealed preferences assumption.

    The merger of Behavioral Economics and Public Economics has required the formulation and

    re�nement of new paradigms for evaluating economic welfare. Accordingly, the chapter begins in

    Section 2 with a review of recent developments involving the foundations of Behavioral Welfare

    Economics. We distinguish between two main schools of thought, one that employs choice-oriented

    methods, another that relies on measures of self-reported well-being. We articulate the foundations

    for each approach, explain strategies for implementation, and discuss limitations. Additional topics

    include paternalism and alternatives to welfarism.

    While Section 2 focuses on foundational conceptual issues such as the nature of economic welfare

    and the de�nition of a �mistake,� as well as on classes of empirical strategies for quantifying mistakes,

    the next three sections examine concrete aspects of policy design and evaluation, as well as empirical

    implementation. The general conceptual framework usefully disciplines the applications, sometimes

    in subtle and surprising ways, and it clari�es their interpretation. However, readers whose interests

    lie in concrete policy analysis will �nd that it is possible to read Sections 3 through 5 without �rst

    absorbing all of Section 2.

    In Section 3 we summarize research on policies targeting commodities. We use a simple model

    to illustrate how changes in the commodity tax a�ect social welfare when a bias arises either from

    consumption �internalities� (i.e., people over-