Fiscal Policy as a Temptation Control Device
We formulate an overlapping generations model with temptation and self-control preferences and incomplete market for commitment devices to study the role of two fiscal programs: social security and saving subsidy. In our environment, the distortions created by such fiscal programs work as a corrective tool that mitigates the adverse effect of succumbing to temptation on inter-temporal allocation and releases severity of self-control problem. Our results indicate that both fiscal programs potentially lead to welfare gains; however, the driving mechanisms are different. Welfare gains associated with a social security program result mainly from releasing self-control costs while welfare gains associated with a saving subsidy program are mainly driven by mitigating inter-temporal allocation distortion. In addition, we also find that the direction and size of welfare effects vary substantially when allowing for different tax-financing instruments as well as when accounting for general equilibrium price adjustments.
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