27 Pages Posted: 19 Jun 2012
Date Written: June 19, 2012
Adaptation is omnipresent but people systematically fail to correctly anticipate the degree to which they adapt. This leads individuals to make inefficient intertemporal decisions. This paper concerns optimal income taxation to correct for such anticipation-biases in a framework where consumers adapt to earlier consumption levels through a habit-formation process. The analysis is based on a general equilibrium OLG model with endogenous labor supply and savings where each consumer lives for three periods. Our results show how a paternalistic government may correct for the effects of anticipation-bias through a combination of time-variant marginal labor income taxes and savings subsidies. Furthermore, the optimal policy mix remains the same, irrespective of whether consumers commit to their original life-time plan for work hours and savings decided upon in the first period of life or re-optimize later on when realizing the failure to adapt.
Keywords: optimal taxation, adaptation, habit-formation, anticipation-bias, paternalism
JEL Classification: D030, D610, D910, H210
Suggested Citation: Suggested Citation
Aronsson, Thomas and Schöb, Ronnie, Adaptation, Anticipation-Bias and Optimal Income Taxation (June 19, 2012). CESifo Working Paper Series No. 3840. Available at SSRN: https://ssrn.com/abstract=2087560