Optimal Nonlinear Income Taxation with Habit Formation
AbstractIt has recently been shown that incorporating "keeping up with the Joneses" preferences into a prototypical two-ability-type optimal nonlinear taxation model leads to higher marginal income tax rates for both types of agents. Specifically, the high-skill type faces a positive marginal income tax rate, rather than zero as in the conventional case. In this paper, agents' utility functions are postulated to exhibit "habit formation in consumption" such that the prototypical two-ability-type optimal nonlinear taxation model becomes a dynamic analytical framework. We show that if the government can commit to its future fiscal policy, the presence of consumption habits does not affect the standard results on optimal marginal income tax rates. By contrast, if the government cannot pre-commit, the high-skill type will face a negative marginal income tax rate, whereas the effect of habit formation on the low-skill type's marginal tax rate is ambiguous.
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Bibliographic InfoPaper provided by University of California at Riverside, Department of Economics in its series Working Papers with number 200810.
Length: 22 pages
Date of creation: Aug 2008
Date of revision: Aug 2008
Income Taxation; Habit Formation; Commitment;
Other versions of this item:
- Jang‐Ting Guo & Alan Krause, 2011. "Optimal Nonlinear Income Taxation with Habit Formation," Journal of Public Economic Theory, Association for Public Economic Theory, vol. 13(3), pages 463-480, 06.
- H21 - Public Economics - - Taxation, Subsidies, and Revenue - - - Efficiency; Optimal Taxation
- H24 - Public Economics - - Taxation, Subsidies, and Revenue - - - Personal Income and Other Nonbusiness Taxes and Subsidies
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