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67 II Behavioral Economics and Public Finance in Practice Having extracted the relevant elements from psychological research and developed a framework for behavioral analysis in part 1, we can now examine topics in public finance through the lens of behavioral economics. Our examination focuses on the policy problems usually considered in traditional public finance. First we address market failures due to both information asymmetries and externalities including public goods. Then we tackle issues in poverty and inequality. Finally we address a set of questions related to taxation and revenue. For each, we consider the implications of a behavioral approach for the diagnosis of policy problems, the description of policy objectives, and the design of policy responses. In chapter 4, “Asymmetric Information,” we discuss the implications of behavioral economics for policy problems that, in the standard view, stem from asymmetries of information. We show how behavioral tendencies both interact with adverse selection and moral hazard and also operate alongside them to create new challenges for policy questions related to old-age insurance, health insurance, and unemployment insurance, and for each we derive implications for policy design. In chapter 5, “Externalities and Public Goods,” we focus on the implications of behavioral economics for our understanding of policy problems that arise due to externalities. We show how behavioral tendencies can interact with classic externalities and how they can lead directly to new types of externalities. To illustrate the former, we use an extended example of environmental externalities in the case of energy consumption; to illustrate the latter we use an example of externalities related to public health. We separate out some of the behavioral Part 04-0498-0 ch4.indd 67 1/3/11 3:28 PM 68 behavioral economics and public finance in practice implications particular to the issue of public goods. And we give a brief treatment to some special implications of behavioral economics for public education. In chapter 6, “Poverty and Inequality,” we take up the analysis of the social welfare costs associated with poverty and inequality and the concomitant policy response. We discuss how behavioral economics changes how we think about some of the welfare consequences of inequality as well as how behavioral economics changes our thinking about the costs and consequences of poverty. We develop implications for the design of transfer policies, focusing on the targeting and delivery of benefits, the relationship between program benefits and participant outcomes, and the consequences of benefits for work incentives. Finally, in chapter 7, “Taxation and Revenue,” we address the implications of behavioral economics for the design of policies intended to raise revenue in an efficient and equitable manner. We consider first how behavioral tendencies mediate how people perceive and respond to taxes and then explore what that means for understanding both the efficiency costs of taxes as well as their incidence . We derive some implications for tax policy, which we apply to issues in the design of commodity taxes, income and other labor taxes, and capital taxes. 04-0498-0 ch4.indd 68 1/3/11 3:28 PM ...

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