thanks to arbitrage, rational people stand to profit when irrational people let prices and wages stray from efficient levels. That’s what justifies the economist’s assumption of rationality—a small number of rational profit-seekers keep markets rational as a whole even when many participants aren’t.
Unfortunately, tax policy has no such mechanism. Tax policymakers suffer the same cognitive biases as everyone else, but the "market" for tax policy—made up of legislators, voters and lobbyists—is much less self-correcting. In traditional markets, bad business practices get pushed out by competition, and bad pricing decisions get corrected through arbitrage. But in tax policy, inefficient tax laws can survive on the books for generations.
Chamberlain cites a paper by Edward J. McCaffery and Jonathan Baron that looks at the irrational beliefs that people tend to have about taxes.
One theme of Learning Economics is that markets learn to eliminate errors, but governments do not. Thus, government intervention tends to have at best a one-time benefit of increased efficiency. Over time, any efficiency gains will be reversed, as political sclerosis sets in.
For Discussion. What examples come to mind of government policies that were initially successful but ultimately proved resistant to change and detrimental?