Wednesday, April 17, 2013

The price tag of a shirt: with or without the tax?

Well, for a rational consumer, it shouldn't make a difference if a shirt became more expensive because A&F decided to up the price or as a result of a higher indirect tax.  Guess again!  It does make a difference!  This is what  Raj Chetty, the 2013 John Bates Clark award winner found in his paper Salience and Taxation: Theory and Evidence:

In Chetty’s most cited study, “Salience and Taxation: Theory and Evidence,” he hypothesizes that sales taxes are less salient to consumer behavior than the posted price, and provides two examples.  First, he shows using state-level data on beer sales that sales tax changes have smaller effects than posted prices.  Second, the authors convinced a large retail store to post the sales-tax-inclusive prices of selected relatively high-cost items, alongside other products posted with the pre-tax price.  Using a difference-in-difference-in-difference design, they found that posting final tax-inclusive prices led to lower sales.  Randomly selected individuals were aware of the existence (and magnitude) of the sales tax, so ignorance of the tax cannot explain the results.  Finally, Chetty shows that because of this salience effect, customers bear far more of the burden of the sales tax than conventional public finance formulas predict. (quoted from the AEA link above)
This is a New York Times piece on Chetty worth checking out: Raj Chetty Wins the John Bates Clark Medal (photo from article)

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