Incentive Separability

We consider a general mechanism-design environment with incentive constraints resulting from frictions such as adverse selection or moral hazard. A set of decisions is defined as incentive-separable if, starting at an initial allocation, perturbing these decisions along agents’ indifference curves preserves the incentive constraints. We show that, under regularity conditions, the optimal mechanism allows agents to make unrestricted choices over incentive-separable decisions, given some prices and budgets. This finding extends and unifies the classical results on the optimal taxation of commodities (Atkinson–Stiglitz and Diamond–Mirrlees theorems) and provides a novel justification for in-kind redistribution programs similar to food stamps.