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Too slow a change? Deep habits, consumption shifts and transitory tax

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  • van den Bijgaart, I.M.

    () (Department of Economics, School of Business, Economics and Law, Göteborg University)

Abstract

This paper studies shifts in the consumption bundle when consumption is subject to habit formation, and consumers do not internalize this habit formation process. Habits are goodspecific, or ’deep’, and cause persistence in good-specific consumption. In addition, at the aggregate level, habits act as benchmark against which consumption is evaluated. I establish that a rapid transition is optimal if the persistence effect is relatively strong, and determine the path of taxes or subsidies that implements this transition, both when goods are produced competitively and when they are produced by monopolists. To explore the quantitative implications of the model I consider the introduction of a 10 percent charge on a subset of goods. I find that consumption adjusts inefficiently fast; implementing first-best adjustment requires a transitory discount of up to 60 percent of the cost increase.

Suggested Citation

  • 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.
  • Handle: RePEc:hhs:gunwpe:0701
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    File URL: http://hdl.handle.net/2077/52586
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    More about this item

    Keywords

    habit formation; projection bias; consumption shifts; optimal taxation;
    All these keywords.

    JEL classification:

    • D11 - Microeconomics - - Household Behavior - - - Consumer Economics: Theory
    • D62 - Microeconomics - - Welfare Economics - - - Externalities
    • H21 - Public Economics - - Taxation, Subsidies, and Revenue - - - Efficiency; Optimal Taxation
    • H23 - Public Economics - - Taxation, Subsidies, and Revenue - - - Externalities; Redistributive Effects; Environmental Taxes and Subsidies

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