Simulations of fundamental tax reform with irrational households

Michael Williams ()
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Michael Williams: University of Saint Thomas

Economics Bulletin, 2005, vol. 8, issue 3, 1-11

Abstract: Dynamic tax models have been devised to examine the effects of fundamental tax reform replacing the current U. S. federal tax system with a national retail sales tax. These models impose a constant and positive rate of time preference on households, in the tradition of the rational, time-consistent consumer. Evidence suggests, however, that households are impatient and time-inconsistent, questioning the validity of a constant rate of time preference. This paper modifies an existing dynamic life-cycle tax model so that it can incorporate this time inconsistency, using a construct known as hyperbolic discounting. We find a significant change in the model's predictions of the effects of fundamental tax reform, including smaller short term losses and smaller long term gains, when the standard assumption of a constant rate of time preference is replaced with the hyperbolic discounting assumption.

JEL-codes: D1 H2 (search for similar items in EconPapers)
Date: 2005-01-26
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Persistent link: https://EconPapers.repec.org/RePEc:ebl:ecbull:eb-04h20013

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