Tax Salience vs. Price Uncertainty: Disentangling the Effects of Attention and Rational Habits

Dec 2014 | 736

Authors: Rebecca K Scott

A recent surge of literature on tax salience has included studies that use tax type as a proxy for salience.  The relationship between tax type and salience is not always apparent, however, nor is salience the only feature by which taxes differ.  In fact, taxes' behaviour over time suggests an alternative explanation for consumers' tax sensitivity: rational habits or forward-looking investment.  Consumers affected by these intertemporal issues will be more responsive to price components that carry stronger signals about future prices-price components such as the specific taxes posited to be particularly salient.  This paper develops a model to disentangle and test for tax salience and rational habits effects.  Differentiating the two effects is important, as they carry vastly different policy implications: tax salience implies that publicity and nominal incidence matter; rational habits imply all that matters is an instrument's effects on price behaviour.  Examining the case of beer demand, I find evidence that favours a rational habits mechanism over a salience effect.  Examining the case of gasoline demand, I find rational habits to be the more plausible explanation for consumers' sensitivity to specific taxes, though a salience effect cannot be ruled out definitively.

JEL Codes: D12, Q41, H30

Keywords: gasoline demand, tax salience, rational habits, price elasticity

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