IDEAS home Printed from https://ideas.repec.org/a/bla/jpbect/v13y2011i3p463-480.html
   My bibliography  Save this article

Optimal Nonlinear Income Taxation with Habit Formation

Author

Listed:
  • JANG‐TING GUO
  • ALAN KRAUSE

Abstract

It has recently been shown that incorporating "keeping up with the Joneses" preferences into a prototypical two-ability-type optimal nonlinear taxation model leads to higher marginal income tax rates for both types of agents. Specifically, the high-skill type faces a positive marginal income tax rate, rather than zero as in the conventional case. In this paper, agents' utility functions are postulated to exhibit "habit formation in consumption" such that the prototypical two-ability-type optimal nonlinear taxation model becomes a dynamic analytical framework. We show that if the government can commit to its future fiscal policy, the presence of consumption habits does not affect the standard results on optimal marginal income tax rates. By contrast, if the government cannot pre-commit, the high-skill type will face a negative marginal income tax rate, whereas the effect of habit formation on the low-skill type's marginal tax rate is ambiguous.
(This abstract was borrowed from another version of this item.)

Suggested Citation

  • Jang‐Ting Guo & Alan Krause, 2011. "Optimal Nonlinear Income Taxation with Habit Formation," Journal of Public Economic Theory, Association for Public Economic Theory, vol. 13(3), pages 463-480, June.
    • Handle: RePEc:bla:jpbect:v:13:y:2011:i:3:p:463-480
    as

    Download full text from publisher

    To our knowledge, this item is not available for download. To find whether it is available, there are three options:
    1. Check below whether another version of this item is available online.
    2. Check on the provider's web page whether it is in fact available.
    3. Perform a search for a similarly titled item that would be available.

    Other versions of this item:

    References listed on IDEAS

    as
    1. Jang-Ting Guo & Zuzana Janko, 2009. "Reexamination of Real Business Cycles in a Small Open Economy," Southern Economic Journal, John Wiley & Sons, vol. 76(1), pages 165-182, July.
    2. Abel, Andrew B, 1990. "Asset Prices under Habit Formation and Catching Up with the Joneses," American Economic Review, American Economic Association, vol. 80(2), pages 38-42, May.
    3. Jody Overland & Christopher D. Carroll & David N. Weil, 2000. "Saving and Growth with Habit Formation," American Economic Review, American Economic Association, vol. 90(3), pages 341-355, June.
    4. Jaime Alonso‐Carrera & Jordi Caballé & Xavier Raurich, 2004. "Consumption Externalities, Habit Formation and Equilibrium Efficiency," Scandinavian Journal of Economics, Wiley Blackwell, vol. 106(2), pages 231-251, June.
    5. Wen, Yi, 1998. "Can a real business cycle model pass the Watson test?," Journal of Monetary Economics, Elsevier, vol. 42(1), pages 185-203, June.
    6. Craig Brett & John A. Weymark, 2019. "Optimal nonlinear taxation of income and savings without commitment," Journal of Public Economic Theory, Association for Public Economic Theory, vol. 21(1), pages 5-43, February.
    7. Jang-Ting Guo, 2005. "Tax Policy Under Keeping Up with the Joneses and Imperfect Competition," Annals of Economics and Finance, Society for AEF, vol. 6(1), pages 25-36, May.
    8. Marcus Berliant & John O. Ledyard, 2014. "Optimal Dynamic Nonlinear Income Taxes with No Commitment," Journal of Public Economic Theory, Association for Public Economic Theory, vol. 16(2), pages 196-221, April.
    9. John Y. Campbell & John Cochrane, 1999. "Force of Habit: A Consumption-Based Explanation of Aggregate Stock Market Behavior," Journal of Political Economy, University of Chicago Press, vol. 107(2), pages 205-251, April.
    10. Auerbach, Alan J., 2006. "Budget windows, sunsets, and fiscal control," Journal of Public Economics, Elsevier, vol. 90(1-2), pages 87-100, January.
    11. Oswald, Andrew J., 1983. "Altruism, jealousy and the theory of optimal non-linear taxation," Journal of Public Economics, Elsevier, vol. 20(1), pages 77-87, February.
    12. Martin S. Eichenbaum & Lars Peter Hansen & Kenneth J. Singleton, 1988. "A Time Series Analysis of Representative Agent Models of Consumption and Leisure Choice Under Uncertainty," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 103(1), pages 51-78.
    13. Harald Uhlig & Lars Ljungqvist, 2000. "Tax Policy and Aggregate Demand Management under Catching Up with the Joneses," American Economic Review, American Economic Association, vol. 90(3), pages 356-366, June.
    14. Aronsson, Thomas & Johansson-Stenman, Olof, 2008. "When the Joneses' consumption hurts: Optimal public good provision and nonlinear income taxation," Journal of Public Economics, Elsevier, vol. 92(5-6), pages 986-997, June.
    15. Abel, Andrew B., 1999. "Risk premia and term premia in general equilibrium," Journal of Monetary Economics, Elsevier, vol. 43(1), pages 3-33, February.
    16. Stiglitz, Joseph E., 1982. "Self-selection and Pareto efficient taxation," Journal of Public Economics, Elsevier, vol. 17(2), pages 213-240, March.
    17. Thomas Gaube, 2007. "Optimum Taxation of Each Year's Income," Journal of Public Economic Theory, Association for Public Economic Theory, vol. 9(1), pages 127-150, February.
    18. Hotz, V Joseph & Kydland, Finn E & Sedlacek, Guilherme L, 1988. "Intertemporal Preferences and Labor Supply," Econometrica, Econometric Society, vol. 56(2), pages 335-360, March.
    19. Guesnerie,Roger, 1998. "A Contribution to the Pure Theory of Taxation," Cambridge Books, Cambridge University Press, number 9780521629560, November.
    20. Kydland, Finn E & Prescott, Edward C, 1982. "Time to Build and Aggregate Fluctuations," Econometrica, Econometric Society, vol. 50(6), pages 1345-1370, November.
    21. Constantinides, George M, 1990. "Habit Formation: A Resolution of the Equity Premium Puzzle," Journal of Political Economy, University of Chicago Press, vol. 98(3), pages 519-543, June.
    22. Zuzana Janko, "undated". "Reexamination of Real Business Cycles in A Small Open Economy," Working Papers 2008-15, Department of Economics, University of Calgary, revised 11 Jan 2008.
    23. Bill Dupor & Wen-Fang Liu, 2003. "Jealousy and Equilibrium Overconsumption," American Economic Review, American Economic Association, vol. 93(1), pages 423-428, March.
    24. Carroll, Christopher D., 2000. "Solving consumption models with multiplicative habits," Economics Letters, Elsevier, vol. 68(1), pages 67-77, July.
    25. Ireland, N. J., 2001. "Optimal income tax in the presence of status effects," Journal of Public Economics, Elsevier, vol. 81(2), pages 193-212, August.
    Full references (including those not matched with items on IDEAS)

    Citations

    Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
    as


    Cited by:

    1. Jang-Ting Guo & Alan Krause, 2018. "Changing social preferences and optimal redistributive taxation," Oxford Economic Papers, Oxford University Press, vol. 70(1), pages 73-92.
    2. Guo, Jang-Ting & Krause, Alan, 2015. "Dynamic nonlinear income taxation with quasi-hyperbolic discounting and no commitment," Journal of Economic Behavior & Organization, Elsevier, vol. 109(C), pages 101-119.
    3. Alan Krause, 2017. "On redistributive taxation under the threat of high-skill emigration," Social Choice and Welfare, Springer;The Society for Social Choice and Welfare, vol. 48(4), pages 845-856, April.
    4. Alan Krause, 2014. "Optimal Savings Taxation when Individuals Have Different CRRA Utility Functions," Annals of Economics and Statistics, GENES, issue 113-114, pages 207-223.
    5. Guo, Jang-Ting & Krause, Alan, 2015. "Dynamic income taxation without commitment: Comparing alternative tax systems," Economic Modelling, Elsevier, vol. 47(C), pages 319-326.
    6. Guo, Jang-Ting & Krause, Alan, 2014. "Optimal Dynamic Nonlinear Income Taxation Under Loose Commitment," Macroeconomic Dynamics, Cambridge University Press, vol. 18(6), pages 1403-1427, September.
    7. Shigeo Morita, 2017. "Optimal income taxation without commitment: policy implications of durable goods," Economics Bulletin, AccessEcon, vol. 37(4), pages 2917-2934.
    8. Shigeo Morita, 2014. "Optimal income taxation without commitment: policy implications of durable goods," Discussion Papers in Economics and Business 14-32, Osaka University, Graduate School of Economics.
    9. Thomas Aronsson & Ronnie Schöb, 2022. "Habit formation and the pareto-efficient provision of public goods," Social Choice and Welfare, Springer;The Society for Social Choice and Welfare, vol. 59(3), pages 669-681, October.
    10. Chen, Yunmin & Guo, Jang-Ting & Krause, Alan, 2020. "The credibility of commitment and optimal nonlinear savings taxation," Journal of Macroeconomics, Elsevier, vol. 65(C).
    11. Laszlo Goerke, 2021. "Habit formation and wage determination," Managerial and Decision Economics, John Wiley & Sons, Ltd., vol. 42(1), pages 61-76, January.
    12. Goerke, Laszlo, 2020. "An Efficiency-Wage Model with Habit Concerns about Wages," IZA Discussion Papers 13454, Institute of Labor Economics (IZA).
    13. Shigeo Morita, 2022. "The MCPF under the pandemic," Journal of Public Economic Theory, Association for Public Economic Theory, vol. 24(5), pages 993-1015, October.
    14. Shu-Hua Chen, 2012. "On the Growth and Stability Effects of Habit Formation and Durability in Consumption," Annals of Economics and Finance, Society for AEF, vol. 13(2), pages 283-298, November.
    15. Jang-Ting Guo & Alan Krause, 2013. "Optimal nonlinear taxation of income and education expenditures," Oxford Economic Papers, Oxford University Press, vol. 65(1), pages 74-95, January.
    16. Shigeo Morita, 2014. "The time consistent public goods provision," Discussion Papers in Economics and Business 14-31, Osaka University, Graduate School of Economics.
    17. Aronsson, Thomas & Johansson-Stenman, Olof, 2014. "Positional preferences in time and space: Optimal income taxation with dynamic social comparisons," Journal of Economic Behavior & Organization, Elsevier, vol. 101(C), pages 1-23.
    18. Juin‐Jen Chang & Hsueh‐Fang Tsai & Tsung‐Sheng Tsai, 2019. "Optimal Dynamic Taxation with Distinctive Forms of Social Status Attainment," Scandinavian Journal of Economics, Wiley Blackwell, vol. 121(2), pages 808-842, April.
    19. Shigeo Morita & Takuya Obara, 2021. "Public investment criteria under optimal nonlinear income taxation without commitment," Journal of Public Economic Theory, Association for Public Economic Theory, vol. 23(4), pages 732-745, August.

    Most related items

    These are the items that most often cite the same works as this one and are cited by the same works as this one.
    1. Aronsson, Thomas & Johansson-Stenman, Olof, 2014. "Positional preferences in time and space: Optimal income taxation with dynamic social comparisons," Journal of Economic Behavior & Organization, Elsevier, vol. 101(C), pages 1-23.
    2. Aronsson, Thomas & Johansson-Stenman, Olof, 2013. "Publicly Provided Private Goods and Optimal Taxation when Consumers Have Positional Preferences," Working Papers in Economics 558, University of Gothenburg, Department of Economics.
    3. Aronsson, Thomas & Johansson-Stenman, Olof, 2014. "Genuine Saving and Conspicuous Consumption," Working Papers in Economics 605, University of Gothenburg, Department of Economics.
    4. Otrok, Christopher, 2001. "On measuring the welfare cost of business cycles," Journal of Monetary Economics, Elsevier, vol. 47(1), pages 61-92, February.
    5. Aronsson, Thomas & Johansson-Stenman, Olof, 2014. "State-variable public goods and social comparisons," Journal of Environmental Economics and Management, Elsevier, vol. 68(2), pages 390-410.
    6. Aronsson, Thomas & Johansson-Stenman, olof, 2013. "State-Variable Public Goods and Social Comparisons over Time," Working Papers in Economics 555, University of Gothenburg, Department of Economics.
    7. Jaime Alonso‐Carrera & Jordi Caballé & Xavier Raurich, 2004. "Consumption Externalities, Habit Formation and Equilibrium Efficiency," Scandinavian Journal of Economics, Wiley Blackwell, vol. 106(2), pages 231-251, June.
    8. Juin‐Jen Chang & Hsueh‐Fang Tsai & Tsung‐Sheng Tsai, 2019. "Optimal Dynamic Taxation with Distinctive Forms of Social Status Attainment," Scandinavian Journal of Economics, Wiley Blackwell, vol. 121(2), pages 808-842, April.
    9. Jaime Alonso-Carrera & Jordi Caball?Author-Email: jordi.caballe@uab.es & Xavier Raurich, 2001. "Income Taxation with Habit Formation and Consumption Externalities," UFAE and IAE Working Papers 496.01, Unitat de Fonaments de l'Anàlisi Econòmica (UAB) and Institut d'Anàlisi Econòmica (CSIC).
    10. Andrew E. Clark & Paul Frijters & Michael A. Shields, 2006. "Income and happiness: Evidence, explanations and economic implications," PSE Working Papers halshs-00590436, HAL.
    11. Rob Alessie & Federica Teppa, 2010. "Saving and habit formation: evidence from Dutch panel data," Empirical Economics, Springer, vol. 38(2), pages 385-407, April.
    12. Samano, Daniel, 2009. "Explaining Taxes at the Upper Tail of the Income Distribution: The Role of Utility Interdependence," MPRA Paper 19112, University Library of Munich, Germany.
    13. Cecilia García-Peñalosa & Stephen Turnovsky, 2008. "Consumption externalities: a representative consumer model when agents are heterogeneous," Economic Theory, Springer;Society for the Advancement of Economic Theory (SAET), vol. 37(3), pages 439-467, December.
    14. Liu, Chia-ying & Chang, Juin-jen, 2011. "Keeping up with the Joneses, consumer ethnocentrism, and optimal taxation," Economic Modelling, Elsevier, vol. 28(4), pages 1519-1525, July.
    15. Aronsson, Thomas & Johansson-Stenman, Olof, 2008. "Positional Concerns with Multiple Reference Points: Optimal Income Taxation and Public Goods in an OLG Model," Working Papers in Economics 304, University of Gothenburg, Department of Economics.
    16. Aronsson, Thomas & Johansson-Stenman, Olof, 2011. "State-Variable Public Goods When Relative Consumption Matters: A Dynamic Optimal Taxation Approach," Umeå Economic Studies 828, Umeå University, Department of Economics.
    17. Thomas Aronsson & Olof Johansson-Stenman, 2014. "When Samuelson Met Veblen Abroad: National and Global Public Good Provision when Social Comparisons Matter," Economica, London School of Economics and Political Science, vol. 81(322), pages 224-243, April.
    18. Kris Jacobs, 2001. "Estimating Nonseparable Preference Specifications for Asset Market Participants," CIRANO Working Papers 2001s-12, CIRANO.
    19. M Boschi & S d'Addona & A Goenka, 2012. "Testing external habits in an asset pricing model," CAMA Working Papers 2012-20, Centre for Applied Macroeconomic Analysis, Crawford School of Public Policy, The Australian National University.
    20. Been-lon Chen & Yu-shan Hsu, 2009. "Is admiration a source of indeterminacy when the speed of habit formation is finite?," Economics Bulletin, AccessEcon, vol. 29(4), pages 3041-3049.

    More about this item

    JEL classification:

    • H21 - Public Economics - - Taxation, Subsidies, and Revenue - - - Efficiency; Optimal Taxation
    • H24 - Public Economics - - Taxation, Subsidies, and Revenue - - - Personal Income and Other Nonbusiness Taxes and Subsidies

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:bla:jpbect:v:13:y:2011:i:3:p:463-480. See general information about how to correct material in RePEc.

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a bibliographic reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: Wiley Content Delivery (email available below). General contact details of provider: https://edirc.repec.org/data/apettea.html .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service. RePEc uses bibliographic data supplied by the respective publishers.