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Habit Formation and Labour Supply

Author

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  • Pestieau, Pierre
  • Cremer, Helmuth
  • De Donder, Philippe
  • Maldonado, Darío

Abstract

This paper shows that the combination of habit formation - present consumption creating additional consumption needs in the future - and myopia may explain why some retirees are forced to 'unretire', i.e., unexpectedly return to work. It also shows that when myopia about habit formation leads to unretirement there is a case for government's intervention. In a first-best setting the optimal solution can be decentralized by a simple 'Pigouvian' (paternalistic) consumption tax (along with suitable lump-sum taxes). In a second-best setting, when personalized lump-sum transfers are not available, consumption taxes may have conflicting paternalistic and redistributive effects. We study the design of consumption taxes in such a setting when myopic individuals differ in productivity.

Suggested Citation

  • Pestieau, Pierre & Cremer, Helmuth & De Donder, Philippe & Maldonado, Darío, 2008. "Habit Formation and Labour Supply," CEPR Discussion Papers 6776, C.E.P.R. Discussion Papers.
    • Handle: RePEc:cpr:ceprdp:6776
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    References listed on IDEAS

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    1. Nicole Maestas, 2007. "Back to Work: Expectations and Realizations of Work after Retirement," Working Papers 196.2, RAND Corporation.
    2. Fehr, Ernst & Zych, Peter K., 2008. "Intertemporal Choice under Habit Formation," Handbook of Experimental Economics Results, in: Charles R. Plott & Vernon L. Smith (ed.), Handbook of Experimental Economics Results, edition 1, volume 1, chapter 98, pages 923-928, Elsevier.
    3. Jean‐Marie Lozachmeur, 2006. "Optimal Age‐Specific Income Taxation," Journal of Public Economic Theory, Association for Public Economic Theory, vol. 8(4), pages 697-711, October.
    4. Jonathan Gruber & David A. Wise, 1999. "Social Security and Retirement around the World," NBER Books, National Bureau of Economic Research, Inc, number grub99-1.
    5. Hammond, Peter & Myles, Gareth (ed.), 2000. "Incentives, Organization, and Public Economics: Papers in Honour of Sir James Mirrlees," OUP Catalogue, Oxford University Press, number 9780199242290.
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    Cited by:

    1. Helmuth Cremer & Philippe De Donder & Dario Maldonado & Pierre Pestieau, 2009. "Forced Saving, Redistribution, and Nonlinear Social Security Schemes," Southern Economic Journal, John Wiley & Sons, vol. 76(1), pages 86-98, July.
    2. Ricky Kanabar, 2012. "Unretirement in England: An empirical perspective," Discussion Papers 12/31, Department of Economics, University of York.
    3. Matti Tuomala & Sanna Tenhunen, 2013. "On the design of an optimal non-linear tax/pension system with habit formation," International Tax and Public Finance, Springer;International Institute of Public Finance, vol. 20(3), pages 485-512, June.

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    More about this item

    Keywords

    Habit formation; Myopia; Unretiring;
    All these keywords.

    JEL classification:

    • 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
    • H55 - Public Economics - - National Government Expenditures and Related Policies - - - Social Security and Public Pensions

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