Public Finance with Behavioural Agents

Behavioural economics has influenced the way governments design public policies, such as online simulators and nudges, to better understand individual behaviors and improve predictions of tax revenue and design better-suited incentives.

Format: Paperback / softback
Length: 75 pages
Publication date: 22 December 2022
Publisher: Cambridge University Press

The impact of recent developments in behavioral economics on public policy design has been profound. Governments are now providing citizens with access to online simulators to navigate tax and benefits systems, while relying more heavily on nudges to influence individual decisions. The growing interest in Behavioural Public Finance stems from the belief that a deeper understanding of individual behaviors can enhance predictions of tax revenue and facilitate the creation of more effective incentives for retirement savings, job searches, education, and medical care.

In this Element, we explore how Behavioural Economics has revolutionized our understanding of fiscal policies. We examine how behavioral insights can be used to design policies that are more effective in achieving social welfare objectives. We also discuss the challenges and limitations of applying behavioral principles to public policy, such as the potential for unintended consequences and the need for robust evidence-based analysis.

One of the key insights from behavioral economics is that people are not always rational decision-makers. Instead, they are influenced by a range of cognitive biases, emotions, and social norms that can lead to suboptimal choices. For example, people may be biased towards immediate rewards, overvalue risky options, or be influenced by the opinions of others.

By recognizing these biases, governments can design policies that counteract them. For instance, policymakers can use nudges, such as default options or reminders, to encourage individuals to make choices that are in their long-term best interests. Nudges have been successfully used in a variety of contexts, including promoting healthy eating, increasing savings rates, and reducing smoking.

Another area where behavioral economics has made a significant impact is in the design of fiscal policies. By understanding the factors that influence individual tax compliance, governments can create policies that are more effective in raising revenue. For example, policymakers can use behavioral insights to design tax incentives that are more targeted towards high-income individuals, who are more likely to be influenced by marginal tax rates.

However, it is important to note that the application of behavioral principles to public policy is not without its challenges. One of the biggest challenges is ensuring that policies are implemented in a way that is equitable and does not discriminate against certain groups of individuals. Another challenge is the need for robust evidence-based analysis to support the effectiveness of policies.

In conclusion, the impact of recent developments in behavioral economics on public policy design has been significant. By recognizing the cognitive biases and emotions that influence individual decision-making, governments can design policies that are more effective in achieving social welfare objectives. The growing interest in Behavioural Public Finance provides a promising avenue for policymakers to create more effective and equitable policies that promote economic growth and well-being.

ISBN-13: 9781009014229