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General Equilibrium Tax Policy with Hyperbolic Consumers

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  • Toke Ward Petersen

Abstract

Recently David Laibson and others have argued in favor of using hyperbolic discount functions. The purpose of this paper is to investigate whether conventional wisdom, based on the standard model with exponential discounting, also holds in the case where consumers have hyperbolic discount functions. In other words do hyperbolic preferences matter for practical policy evaluation? Within the framework of a suitably modified standard General Equilibrium model à la Auerbach and Kotlikoff, this is done by simulations of both fundamental changes in the tax base, as well as more marginal experiments comparing the excess burden of taxation. Based on the simulations it turns out that the answer to the question is a maybe: If preferences are sufficiently hyperbolic then policy conclusions change. Unfortunately this degree of hyperbolicness in the discounting function is at the level that is considered realistic by empirical studies.

Suggested Citation

  • Toke Ward Petersen, 2001. "General Equilibrium Tax Policy with Hyperbolic Consumers," DREAM Working Paper Series 200101, Danish Rational Economic Agents Model, DREAM.
  • Handle: RePEc:dra:wpaper:200101
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    References listed on IDEAS

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    1. Harris, Christopher & Laibson, David, 2001. "Dynamic Choices of Hyperbolic Consumers," Econometrica, Econometric Society, vol. 69(4), pages 935-957, July.
    2. Lars Haagen Pedersen & Peter Stephensen, 1999. "Earned Income Tax Credit in a Disaggregated Labor Market with Minimum Wage Contracts," DREAM Working Paper Series 199901, Danish Rational Economic Agents Model, DREAM.
    3. Thaler, Richard, 1981. "Some empirical evidence on dynamic inconsistency," Economics Letters, Elsevier, vol. 8(3), pages 201-207.
    4. E. S. Phelps & R. A. Pollak, 1968. "On Second-Best National Saving and Game-Equilibrium Growth," The Review of Economic Studies, Review of Economic Studies Ltd, vol. 35(2), pages 185-199.
    5. David Laibson & Andrea Repetto & Jeremy Tobacman, 2000. "A Debt Puzzle," NBER Working Papers 7879, National Bureau of Economic Research, Inc.
    6. David Laibson, 1997. "Golden Eggs and Hyperbolic Discounting," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 112(2), pages 443-478.
    7. David I. Laibson, 1996. "Hyperbolic Discount Functions, Undersaving, and Savings Policy," NBER Working Papers 5635, National Bureau of Economic Research, Inc.
    8. Ballard, Charles L & Shoven, John B & Whalley, John, 1985. "General Equilibrium Computations of the Marginal Welfare Costs of Taxes in the United States," American Economic Review, American Economic Association, vol. 75(1), pages 128-138, March.
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    Cited by:

    1. Toke Ward Petersen, 2001. "Interest Rate Risk over the Life-Cycle: A General Equilibrium Approach," DREAM Working Paper Series 200103, Danish Rational Economic Agents Model, DREAM.
    2. Liutang Gong & Heng-fu Zou, 1998. "Fiscal Policies in a Stochastic Model with Hyperbolic Discounting," CEMA Working Papers 103, China Economics and Management Academy, Central University of Finance and Economics.
    3. Toke Ward Petersen, 2001. "The Optimal Level of Progressivity in the Labor Income Tax in a Model with Competitive Markets and Idiosyncratic Uncertainty," DREAM Working Paper Series 200104, Danish Rational Economic Agents Model, DREAM.
    4. Toke Ward Petersen, 2001. "Indivisible Labor and the Welfare Effects of Labor Income Tax Reform," DREAM Working Paper Series 200102, Danish Rational Economic Agents Model, DREAM.

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    More about this item

    Keywords

    hyperbolic discounting; tax reform; marginal excess burden;
    All these keywords.

    JEL classification:

    • C68 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Computable General Equilibrium Models
    • D91 - Microeconomics - - Micro-Based Behavioral Economics - - - Role and Effects of Psychological, Emotional, Social, and Cognitive Factors on Decision Making
    • H21 - Public Economics - - Taxation, Subsidies, and Revenue - - - Efficiency; Optimal Taxation
    • E21 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Consumption; Saving; Wealth

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