Airfare Transparency Made the Free Market Freer

Cass R. Sunstein

(Bloomberg Opinion) -- Have you ever shopped online for something (say, a hotel room) and selected an option with an excellent price only to learn, at the time of checkout, that the price is much higher than originally advertised?

That happens a lot. A key reason is that advertised prices often exclude taxes and fees.

Even if there is some disclosure of that fact (“taxes and fees not included”), consumers might not pay attention. Having initially seen a reasonable price and settled on their choice, a lot of them just put in their credit card number even if, at the final stage, they are shocked to see the unexpectedly high cost.

In these circumstances, new research suggests that disclosure regulation can do a lot of good.

The research is a nice response to contemporary skeptics of the benefits of federal regulation. It should guide policymakers in both state and federal governments, and it offers important lessons for businesses as well.

The tale begins on Jan. 26, 2012, the effective date of a regulation from the U.S. Department of Transportation requiring online travel agents and air carriers to include all mandatory fees and taxes in their advertised fares.(1) The regulation was influenced by research in behavioral economics suggesting that when taxes are revealed separately from base prices, consumers will underreact to them – and may end up losing a lot of money.

Known as a “full fare advertising rule,” the regulation appears to be the first national mandate requiring tax-inclusive pricing.

The economists Sebastian Bradley of Drexel University and Naomi Feldman of Hebrew University of Jerusalem studied the effects of the mandate. Their research is highly technical, but the basic lessons are clear: Airline passengers have been big winners. 

Before the regulation went into effect, airlines succeeded in passing virtually all ticket taxes onto consumers, apparently for the expected reason: The taxes were revealed at a late stage of online purchasing. When people were making their initial searches, they just didn’t see them. While they could have searched for the taxes, most of them didn’t.

Bradley and Feldman found that after the regulation went into effect, and consumers could see the full fare, airlines were no longer able to pass the full amount of the taxes onto consumers. As a result, they lost revenue. Some of them responded by cutting their base fares, to reduce the risk that customers would perceive an immediate fare increase as a result of tax-inclusive pricing.

All in all, the regulation produced a substantial transfer of money from airlines to consumers. The larger lesson is that disclosure requirements can have what Bradley and Feldman called a “profound influence” on market arrangements, potentially making consumers better off.

These findings fit well with new research in the area of consumer protection, also suggesting that regulation of hidden fees can help consumers. For example, regulatory restrictions on late-payment charges and fees for exceeding credit limits, including disclosure requirements, have been found to have delivered billions of dollars in annual benefits to consumers. Research from the Federal Trade Commission suggests that consumers would be helped with more transparency about hotel “resort fees,” which often come as a big surprise.

Many people are greatly concerned about what they see as online manipulation of consumers, sometimes through the use of algorithms, sometimes through a diverse assortment of clever strategies known as “dark patterns,” by which designers exploit people’s cognitive biases, including their limited attention. The whole area deserves serious consideration from regulators.

But here as elsewhere, it’s smart to start with easy cases. When costs are not fully transparent to consumers, there is a market failure — and disclosure mandates are likely to do a great deal of good.

(1) I was administrator of the Office of Information and Regulatory Affairs at the time and helped oversee the development and promulgation of this regulation.

To contact the author of this story: Cass R. Sunstein at csunstein1@bloomberg.net

To contact the editor responsible for this story: Jonathan Landman at jlandman4@bloomberg.net

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

Cass R. Sunstein is a Bloomberg Opinion columnist. He is the author of “The Cost-Benefit Revolution” and a co-author of “Nudge: Improving Decisions About Health, Wealth and Happiness.”

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