Temptation and Taxation

29 Pages Posted: 30 Mar 2004 Last revised: 14 Sep 2010

See all articles by Per Krusell

Per Krusell

Princeton University - Department of Economics; Stockholm University - Institute for International Economic Studies (IIES); Centre for Economic Policy Research (CEPR)

Burhanettin Kuruscu

University of Toronto - Department of Economics

Anthony A. Smith

Yale University - Cowles Foundation

Date Written: March 1, 2005

Abstract

We study optimal taxation when consumers have temptation and self-control problems. Embedding the class of preferences developed by Gul and Pesendorfer into a standard macroeconomic setting, we first prove, in a two-period model, that the optimal policy is to subsidize savings when consumers are tempted by “excessive” impatience. The savings subsidy improves welfare because it makes succumbing to temptation less attractive. We then study an economy with a long but finite horizon which nests as a special case the Phelps-Pollak-Laibson multiple-selves model (thereby providing guidance on how to evaluate welfare in this model). We prove that when period utility is logarithmic the optimal savings subsidies increase over time for any finite horizon. Moreover, as the horizon grows large, the optimal policy prescribes a constant subsidy, in contrast to the well-known Chamley-Judd result.

Keywords: consumption and saving, temptation, self-control, tax policy

Suggested Citation

Krusell, Per L. and Kuruscu, Burhanettin and Smith, Anthony A., Temptation and Taxation (March 1, 2005). Available at SSRN: https://ssrn.com/abstract=519502 or http://dx.doi.org/10.2139/ssrn.519502

Per L. Krusell (Contact Author)

Princeton University - Department of Economics ( email )

111 Fisher Hall
Princeton, NJ
United States
609-258-4003 (Phone)
609-258-6419 (Fax)

HOME PAGE: http://rincewind.iies.su.se/%7Ekrusell/

Stockholm University - Institute for International Economic Studies (IIES) ( email )

Stockholm, SE-10691
Sweden
+46 0 8 16 30 73 (Phone)
+46 0 8 16 41 77 (Fax)

HOME PAGE: http://rincewind.iies.su.se/%7Ekrusell/

Centre for Economic Policy Research (CEPR)

London
United Kingdom

Burhanettin Kuruscu

University of Toronto - Department of Economics ( email )

Toronto, Ontario M5S 3G8
Canada

HOME PAGE: http://https://sites.google.com/site/bkuruscu

Anthony A. Smith

Yale University - Cowles Foundation ( email )

Box 208281
New Haven, CT 06520-8281
United States

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