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Optimal taxation in a habit formation economy

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  • Koehne, Sebastian
  • Kuhn, Moritz

Abstract

This paper studies habit formation in consumption preferences in a dynamic Mirrlees economy. We derive optimal labor and savings wedges based on a recursive approach. We show that habit formation creates a motive for subsidizing labor supply and savings. In particular, habit formation invalidates the well-known “no distortion at the top” result. We demonstrate that the theoretical findings are quantitatively important: in a parametrized life-cycle model, average labor and savings wedges fall by more than one-third compared with the case of time-separable preferences.

Suggested Citation

  • Koehne, Sebastian & Kuhn, Moritz, 2015. "Optimal taxation in a habit formation economy," Journal of Public Economics, Elsevier, vol. 122(C), pages 31-39.
  • Handle: RePEc:eee:pubeco:v:122:y:2015:i:c:p:31-39
    DOI: 10.1016/j.jpubeco.2014.12.007
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    Citations

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    Cited by:

    1. Winfried Koeniger & Julien Prat, 2018. "Human Capital and Optimal Redistribution," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 27, pages 1-26, January.
    2. Soldatos, Gerasimos T., 2015. "Tax Aversion, Laffer Curve, and the Self-financing of Tax Cuts," MPRA Paper 62470, University Library of Munich, Germany.
    3. Soldatos, Gerasimos, 2014. "Indirect Tax Incidence under Inelastic Underground Economy Demand," MPRA Paper 64598, University Library of Munich, Germany.
    4. Inge van den Bijgaart, 2018. "Too Slow a Change? Deep Habits, Consumption Shifts and Transitory Tax Policy," CESifo Working Paper Series 6958, CESifo Group Munich.
    5. Aronsson, Thomas & Schöb, Ronnie, 2017. "Habit formation and the Pareto-efficient provision of public goods," Discussion Papers 2017/1, Free University Berlin, School of Business & Economics.
    6. van den Bijgaart, Inge, 2016. "Essays in environmental economics and policy," Other publications TiSEM 298bee2a-cb08-4173-9fe1-8, Tilburg University, School of Economics and Management.
    7. van den Bijgaart, I.M., 2017. "Too slow a change? Deep habits, consumption shifts and transitory tax," Working Papers in Economics 701, University of Gothenburg, Department of Economics.

    More about this item

    Keywords

    Optimal taxation; Habit formation; Recursive contracts;

    JEL classification:

    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
    • E21 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Consumption; Saving; Wealth
    • H21 - Public Economics - - Taxation, Subsidies, and Revenue - - - Efficiency; Optimal Taxation

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