with George-Marios Angeletos
We study optimal taxation when agents are rationally inattentive. Using a flexible model of inattention, we show that there is no corrective role for taxes when attention costs satisfy an invariance condition. At the same time, some forms of inattention generate inter-dependence across states– tax decisions in one state are no longer independent of those in other states. This coupling arises because an inattentive demand function depends on the price of goods in multiple states of the world. In contrast to the traditional view, inter-dependence may call for lower tax rates. In addition, it breaks Slutsky matrix symmetry and can justify state-dependent taxation. Finally, we clarify how traditional estimates of elasticities and welfare costs of taxation may be biased when agents are inattentive.