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Incentive separability
Pawel Doligalski (Bristol & GRAPE)
Piotr Dworczak (Northwestern & GRAPE)
Joanna Krysta (Standford)
Filip Tokarski (Stanford GSB)
This project has received funding from the European Research Council (ERC) under the European Union’s Horizon
2020 research and innovation programme (ERC Starting grant IMD-101040122)
1
Efficiency-equity trade-off: distortions are useful for redistribution
• central concept in Public Finance
2
Efficiency-equity trade-off: distortions are useful for redistribution
• central concept in Public Finance
However, sometimes the efficiency-equity trade-off is not there:
• Diamond-Mirrlees ’71: distortionary taxes on firms are redundant
• Atkinson-Stiglitz ’76: differentiated consumption taxes are redundant with
a non-linear income tax
• Sadka ’76, Seade ’77: there should be “no distortion at the top”
We study the general logic behind these results using Mechanism Design
2
What we do
We consider a general framework allowing for complex incentive constraints
- private information, moral hazard, voluntary participation etc
We introduce a new notion of incentive separability
- A set of decisions is incentive-separable if perturbing these decisions along
agents’ indifference curves preserves all incentive constraints.
3
What we do
We consider a general framework allowing for complex incentive constraints
- private information, moral hazard, voluntary participation etc
We introduce a new notion of incentive separability
- A set of decisions is incentive-separable if perturbing these decisions along
agents’ indifference curves preserves all incentive constraints.
Main theorem: It is optimal to allow agents to make unrestricted choices over
incentive-separable decisions, given some prices and budgets.
3
What we do
We consider a general framework allowing for complex incentive constraints
- private information, moral hazard, voluntary participation etc
We introduce a new notion of incentive separability
- A set of decisions is incentive-separable if perturbing these decisions along
agents’ indifference curves preserves all incentive constraints.
Main theorem: It is optimal to allow agents to make unrestricted choices over
incentive-separable decisions, given some prices and budgets.
The theorem allows us to
• Extend and unify Atkinson-Stiglitz and Diamond-Mirrlees theorems
• Propose a novel argument for the optimality of food vouchers
3

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DDKT-Praga.pdf

  • 1. Incentive separability Pawel Doligalski (Bristol & GRAPE) Piotr Dworczak (Northwestern & GRAPE) Joanna Krysta (Standford) Filip Tokarski (Stanford GSB) This project has received funding from the European Research Council (ERC) under the European Union’s Horizon 2020 research and innovation programme (ERC Starting grant IMD-101040122) 1
  • 2. Efficiency-equity trade-off: distortions are useful for redistribution • central concept in Public Finance 2
  • 3. Efficiency-equity trade-off: distortions are useful for redistribution • central concept in Public Finance However, sometimes the efficiency-equity trade-off is not there: • Diamond-Mirrlees ’71: distortionary taxes on firms are redundant • Atkinson-Stiglitz ’76: differentiated consumption taxes are redundant with a non-linear income tax • Sadka ’76, Seade ’77: there should be “no distortion at the top” We study the general logic behind these results using Mechanism Design 2
  • 4. What we do We consider a general framework allowing for complex incentive constraints - private information, moral hazard, voluntary participation etc We introduce a new notion of incentive separability - A set of decisions is incentive-separable if perturbing these decisions along agents’ indifference curves preserves all incentive constraints. 3
  • 5. What we do We consider a general framework allowing for complex incentive constraints - private information, moral hazard, voluntary participation etc We introduce a new notion of incentive separability - A set of decisions is incentive-separable if perturbing these decisions along agents’ indifference curves preserves all incentive constraints. Main theorem: It is optimal to allow agents to make unrestricted choices over incentive-separable decisions, given some prices and budgets. 3
  • 6. What we do We consider a general framework allowing for complex incentive constraints - private information, moral hazard, voluntary participation etc We introduce a new notion of incentive separability - A set of decisions is incentive-separable if perturbing these decisions along agents’ indifference curves preserves all incentive constraints. Main theorem: It is optimal to allow agents to make unrestricted choices over incentive-separable decisions, given some prices and budgets. The theorem allows us to • Extend and unify Atkinson-Stiglitz and Diamond-Mirrlees theorems • Propose a novel argument for the optimality of food vouchers 3
  • 7. Literature review • Redundancy (or not) of commodity taxes with nonlinear income tax Atkinson & Stiglitz (1976); Christiansen (1981); Cremer, Gahvari & Ladoux (1998); Laroque (2005); Kaplow (2006); Gauthier & Laroque (2009); Cremer & Gahvari (1995); Cremer, Pestieau & Rochet (2001); Saez (2002); da Costa & Werning (2002); Golosov, Kocherlakota & Tsyvinski (2003) • Optimal in-kind redistribution Nichols & Zeckhauser (1982); Currie & Gahvari (2008); Akbarpour r ○ Dworczak r ○ Kominers (2023) • Optimality of production efficiency Diamond & Mirrlees (1971); Stiglitz & Dasgupta (1971), Hammond (2000) 4
  • 8. Outline of the talk 1. Framework 2. General results 3. Applications 5
  • 10. • A unit mass of agents with types θ ∈ [0, 1] ≡ Θ, uniformly distributed • Agents’ utility over a vector of K decisions x ∈ RK + U (x, θ) - x contains e.g. consumption of goods, labor supply, effort, ... - U continuous in x, measurable in θ - we make no ”single crossing” assumptions 6
  • 11. • A unit mass of agents with types θ ∈ [0, 1] ≡ Θ, uniformly distributed • Agents’ utility over a vector of K decisions x ∈ RK + U (x, θ) - x contains e.g. consumption of goods, labor supply, effort, ... - U continuous in x, measurable in θ - we make no ”single crossing” assumptions • An allocation rule x : Θ → RK + • associated aggregate allocation: x = ´ x(θ) dθ • associated utility profile Ux , where Ux (θ) = U(x(θ), θ) 6
  • 12. • Social planner with objective function W (Ux , x), - W continuous and weakly decreasing in x - dependence on Ux : redistributive (welfarist) objective - dependence on x: preferences over allocations beyond agents utilities - e.g. (opportunity) cost of resources, preference for tax revenue, aggregate constraints 7
  • 13. • Social planner with objective function W (Ux , x), - W continuous and weakly decreasing in x - dependence on Ux : redistributive (welfarist) objective - dependence on x: preferences over allocations beyond agents utilities - e.g. (opportunity) cost of resources, preference for tax revenue, aggregate constraints • Planner chooses allocation x : Θ → RK + subject to incentive constraints x ∈ I ⊆ (RK +)Θ - no a priori restrictions on I - I can represent IC constraints due to private info, moral hazard, etc. • An allocation x ∈ I is called feasible 7
  • 14. • Social planner with objective function W (Ux , x), - W continuous and weakly decreasing in x - dependence on Ux : redistributive (welfarist) objective - dependence on x: preferences over allocations beyond agents utilities - e.g. (opportunity) cost of resources, preference for tax revenue, aggregate constraints • Planner chooses allocation x : Θ → RK + subject to incentive constraints x ∈ I ⊆ (RK +)Θ - no a priori restrictions on I - I can represent IC constraints due to private info, moral hazard, etc. • An allocation x ∈ I is called feasible • Notation: For a subset of decisions S ⊆ {1, ..., K} : xS = (xi )i∈S x−S = (xi )i̸∈S x = (xS , x−S ) 7
  • 15. Incentive separability Def: Decisions S ⊆ {1, ..., K} are incentive-separable (at feasible alloc x0) if {(xS , x−S 0 ) : U(xS (θ), x−S 0 (θ), θ) = U(x0(θ), θ), ∀θ ∈ Θ} ⊆ I. Decisions S are incentive-separable (IS) if all perturbations of xS that keep all types indifferent satisfy incentive constraints 8
  • 16. Incentive separability Def: Decisions S ⊆ {1, ..., K} are incentive-separable (at feasible alloc x0) if {(xS , x−S 0 ) : U(xS (θ), x−S 0 (θ), θ) = U(x0(θ), θ), ∀θ ∈ Θ} ⊆ I. Decisions S are incentive-separable (IS) if all perturbations of xS that keep all types indifferent satisfy incentive constraints IS is a joint restriction on preferences and incentives. Examples: 1. Voluntary participation: all decisions are IS 2. Private information: decisions S are weakly-separable ⇒ S are IS - S are weakly-separable when U(x, θ) = Ũ(v(xS ), x−S , θ) 3. Moral hazard: hidden action a affects the distribution of observed state ω - U(x, θ) = −c(a) + P ω P(ω|a)uω(yω), yω ∈ RL + - Decisions within each state ω (namely, yω) are IS 4. Easy to extend to combinations of frictions, dynamic private info, aggregate states, ... 8
  • 18. Suppose that decisions S ⊆ {1, ..., K} are incentive-separable Def: A feasible allocation x0 is S-undistorted if xS 0 solves max xS W (Ux0 , (xS , x−S 0 )) s.t. U(xS (θ), x−S 0 (θ), θ) = U(x0(θ), θ), ∀θ ∈ Θ For this talk: assume that S−undistorted allocation exists (we prove it in the paper) 9
  • 19. Suppose that decisions S ⊆ {1, ..., K} are incentive-separable Def: A feasible allocation x0 is S-undistorted if xS 0 solves max xS W (Ux0 , (xS , x−S 0 )) s.t. U(xS (θ), x−S 0 (θ), θ) = U(x0(θ), θ), ∀θ ∈ Θ For this talk: assume that S−undistorted allocation exists (we prove it in the paper) Lemma 1 (Optimality) Any feasible x0 that is not S-undistorted can be improved upon. 9
  • 20. Suppose that decisions S ⊆ {1, ..., K} are incentive-separable Def: A feasible allocation x0 is S-undistorted if xS 0 solves max xS W (Ux0 , (xS , x−S 0 )) s.t. U(xS (θ), x−S 0 (θ), θ) = U(x0(θ), θ), ∀θ ∈ Θ For this talk: assume that S−undistorted allocation exists (we prove it in the paper) Lemma 1 (Optimality) Any feasible x0 that is not S-undistorted can be improved upon. Full proof: Since x0 is not S-undistorted, there exists allocation x∗ = (xS ∗ , x−S 0 ) s.t. 1. Utility levels are unaffected: Ux⋆ = Ux0 , 2. Planner’s objective strictly improves under x∗ relative to x0. Since goods S are incentive-separable, 1. implies that x∗ is also feasible. □ 9
  • 21. A1. U is locally nonsatiated in xS A2. W (Ux , x) is linear in xS with coefficients −λ ≪ 0 - Interpretation: constant marginal costs of producing xS - In the paper: a much weaker condition allowing for curvature in W 10
  • 22. A1. U is locally nonsatiated in xS A2. W (Ux , x) is linear in xS with coefficients −λ ≪ 0 - Interpretation: constant marginal costs of producing xS - In the paper: a much weaker condition allowing for curvature in W Lemma 2 (Decentralization) Any feasible S−undistorted allocation x0 can be decentralized with prices λ. That is, there exists a budget assignment m : Θ → R+ such that, for all θ ∈ Θ, xS 0 (θ) solves max xS ∈R |S| + U(xS , x−S 0 (θ), θ) subject to λ · xS ≤ m(θ). Proof: Follows from consumer duality: Mas-Colell et al. 1995, Prop 3.E.1 □ 10
  • 23. Main theorem Combining Lemmas 1 and 2, we arrive at: Theorem 1 Starting at any feasible allocation x0, the planner’s objective can be improved by allowing agents to purchase incentive-separable goods at prices λ subject to type-dependent budgets (with the improvement being strict if x0 is S-distorted). • There should be no distortions between IS goods • Agents can trade IS goods freely given prices and budgets • With production, prices of IS goods should be equal to marginal costs • Result silent about non-IS goods The results can be easily extended to allow for: • the set of IS goods to depend on type θ and initial allocation x0 • additional constraints faced by the planner: x ∈ F 11
  • 25. APPLICATION 1: ATKINSON-STIGLITZ Atkinson-Stiglitz model: - θ: privately observed productivity - c: vector of consumption of goods (produced with const marginal costs) - L: labor in efficiency units - consumption is weakly separable: U(v(c), L, θ) → consumption goods c are incentive-separable 12
  • 26. APPLICATION 1: ATKINSON-STIGLITZ Atkinson-Stiglitz model: - θ: privately observed productivity - c: vector of consumption of goods (produced with const marginal costs) - L: labor in efficiency units - consumption is weakly separable: U(v(c), L, θ) → consumption goods c are incentive-separable By Theorem 1, it is welfare-improving to let agents trade goods c freely given prices proportional to marginal costs and type-dependent budgets Theorem 1 implies the Atkinson-Stiglitz theorem: - prices proportional to marginal costs → no distortionary taxes on c - type-dependent budgets → implemented with non-linear income tax 12
  • 27. APPLICATION 1: ATKINSON-STIGLITZ Theorem 1 is much more general than the Atkinson-Stiglitz theorem: 1. We allow for more complex settings and incentives - only a subset of commodities may be incentive separable - there may be moral hazard in some decisions (or other incentive problems) - combination of redistributive (Mirrlees) and social-insurance (Varian) strands of optimal income tax literature 2. We rule out any distortionary mechanisms - e.g. quotas, public provision,... 3. What is essential is the ability to implement budgets for S goods, rather than the availability of nonlinear income tax - Theorem 1 applies even if earnings are unobserved (e.g. due to tax evasion) but total expenditure on IS goods is observed 13
  • 28. APPLICATION 2: FOOD VOUCHERS We specialize the model to capture food choices, allowing for some preference heterogeneity. Jensen & Miller (2010): idiosyncratic food tastes more pronounced when food consumption is high. 14
  • 29. APPLICATION 2: FOOD VOUCHERS We specialize the model to capture food choices, allowing for some preference heterogeneity. Jensen & Miller (2010): idiosyncratic food tastes more pronounced when food consumption is high. • E ⊆ {1, ..., K}: various food items, −E : other commodities and decisions • Let v(xE ) denote the nutritional value of food (common to all agents) • Utility function U(x, θ) =    UL(v(xE ), x−E , θ) if v(xE ) ≤ v (only nutrition matters) UH (x, θ) if v(xE ) > v (nutrition and tastes matter) - v: nutritional threshold above which idiosync. food tastes become active 14
  • 30. APPLICATION 2: FOOD VOUCHERS We specialize the model to capture food choices, allowing for some preference heterogeneity. Jensen & Miller (2010): idiosyncratic food tastes more pronounced when food consumption is high. • E ⊆ {1, ..., K}: various food items, −E : other commodities and decisions • Let v(xE ) denote the nutritional value of food (common to all agents) • Utility function U(x, θ) =    UL(v(xE ), x−E , θ) if v(xE ) ≤ v (only nutrition matters) UH (x, θ) if v(xE ) > v (nutrition and tastes matter) - v: nutritional threshold above which idiosync. food tastes become active • θ is privately observed → food items are IS for types θ s.t. v(xE (θ)) ≤ v • Food items produced with const marginal cost in terms of labor 14
  • 31. APPLICATION 2: FOOD VOUCHERS Conflicting motives for taxes on food: - food choices of the poor are IS → suboptimal to distort - the rich exhibit heterogeneous tastes for food → optimal to distort their food choices (Saez, 2002) 15
  • 32. APPLICATION 2: FOOD VOUCHERS Conflicting motives for taxes on food: - food choices of the poor are IS → suboptimal to distort - the rich exhibit heterogeneous tastes for food → optimal to distort their food choices (Saez, 2002) Solution? A food vouchers program: Corollary 1 Consider a feasible allocation x0. The planner’s objective can be improved by assigning budgets to all agents with θ such that v(xE (θ)) ≤ v, and letting them spend these budgets on food items E (but no other goods) priced at marginal cost. - means-tested: allocated only to ”low income” types {θ : v(xE (θ)) ≤ v} - allows to buy food at producer prices: isolates from tax distortions 15
  • 33. APPLICATION 2: FOOD VOUCHERS Conflicting motives for taxes on food: - food choices of the poor are IS → suboptimal to distort - the rich exhibit heterogeneous tastes for food → optimal to distort their food choices (Saez, 2002) Solution? A food vouchers program: Corollary 1 Consider a feasible allocation x0. The planner’s objective can be improved by assigning budgets to all agents with θ such that v(xE (θ)) ≤ v, and letting them spend these budgets on food items E (but no other goods) priced at marginal cost. - means-tested: allocated only to ”low income” types {θ : v(xE (θ)) ≤ v} - allows to buy food at producer prices: isolates from tax distortions Compare to the U.S. food stamps program (SNAP) - means-tested, purchases exempt from commodity taxes (state and local) - however, restricted eligibility of unemployed—suboptimal in our setting 15
  • 34. CONCLUSIONS • Incentive separability: a useful notion to study optimality and decentralization in complex incentive problems • We focused on applications within Public Finance - also in the paper: Atkinson-Stiglitz meet Diamond-Mirrlees • Potential applications in other contexts - employee compensation / principal-agent problems within organizations - monopoly pricing with multiple goods / attributes - ... 16