Abstract
Imperfect information may cause rationally bounded individuals to make consistent mistakes. This paper focuses on potential misperception of prices. Consumers may underestimate the full price of tax-exclusive prices and hence overconsume goods and services. Countries with a significant consumption tax base (for example, a value-added tax) regulate tax-inclusive price presentation to overcome consumers’ biases and thus to protect consumers. The United States is considering the adoption of a federal consumption tax base and therefore may be similarly expected to regulate tax-inclusive price presentation. Based on a theory of optimal taxation, this paper explains why tax-exclusive rather than tax-inclusive prices can be socially desirable. To the extent that tax-exclusive pricing confuses consumers who then ignore non-indicated taxes and overconsume, consumers may be better off. The argument is counterintuitive, in particular for consumer protection advocates: confusion is actually good for consumers. The paper investigates several potential justifications for tax-inclusive pricing, and shows that a reasonably accepted rationale is rather limited in scope and unrelated to consumer-protection motivations. Finally, the paper extends the analysis to income-based taxes and to misleading non-tax (marketing) practices.