How Much can Taxation Alleviate Temptation and Self-Control Problems?

Abstract

We develop a quantitative dynamic general-equilibrium model where agents have preferences featuring temptation and self-control problems, and we apply it in order to understand to what extent standard investment/savings subsidies can improve welfare.

The dynamic model of preferences builds on the Gul-Pesendorfer setting and uses a “quasi-geometric” formulation for temptation, the strength of which is modeled with a separate parameter. When this parameter is infinity, consumers always succumb to the temptation, and our formulation reduces to the model of multiple selves studied elsewhere. We embed the consumer in the typical neoclassical growth setting used for macroeconomic analysis and demonstrate how steady states can be analyzed and how equilibria can be solved. We also propose a way of calibrating the model.

Our preference-based setting gives unequivocal guidance for policy analysis. In our quantitative application, we show that when preferences are such that self-control is limited and consumers instead mainly succumb to the temptation of overconsumption, policy can play an important role.