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Optimal Taxation in Life-Cycle Economies in the Presence of Commitment and Temptation Problems

Author

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  • Cagri Seda Kumru
  • Saran Sarntisart

    ()

Abstract

Self-control problem is an important determinant of individuals. economic decisions. The decision maker’s future utility is affected by unwanted temptation. This implies that implications of various government policies would differ if one incorporates these behavioural aspects. Public finance instruments could, however, be used to correct anomalies created by temptation. The purpose of this paper is to examine the question of optimal taxation when individuals have self-control problems. In order to capture our agents’ temptation towards current consumption, our model make use of the preference structure pioneered by Gul and Pesendorfer and further elaborated by Krusell et al. in the context of optimal taxation. We extend by adding labor choice and besides savings tax, we also analyze capital income tax, consumption tax and labor income tax. Results show that when the analysis is restricted to logarithmic preferences separable in consumption and labor supply, the government should subsidize either capital income or investment as it maximizes both an individual’s commitment utility for consumption and labor supply at the same time. Because individuals consume and supply labor more than their commitment utility, subsidizing improves welfare as it makes temptation less attractive.

Suggested Citation

  • Cagri Seda Kumru & Saran Sarntisart, 2013. "Optimal Taxation in Life-Cycle Economies in the Presence of Commitment and Temptation Problems," ANU Working Papers in Economics and Econometrics 2013-609, Australian National University, College of Business and Economics, School of Economics.
  • Handle: RePEc:acb:cbeeco:2013-609
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    File URL: https://www.cbe.anu.edu.au/researchpapers/econ/wp609.pdf
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    More about this item

    Keywords

    Temptation; self-control; consumption-savings; optimal taxation;

    JEL classification:

    • E21 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Consumption; Saving; Wealth
    • E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy
    • H21 - Public Economics - - Taxation, Subsidies, and Revenue - - - Efficiency; Optimal Taxation

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