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Temptation and taxation with elastic labor

Chung Tran

Economic Modelling, 2018, vol. 70, issue C, 351-369

Abstract: In this paper we study the corrective role of income taxation in a model with the Gul and Pesendorfer type of temptation and self-control preferences embedded with labor/leisure choice. “Excessive” impatience created by the presence of temptation in preferences causes a bias in favour of present consumption and a two-dimensional problem: under-saving and over-supply-of-labor. In such an environment, the two-dimensional problem requires two-dimensional tax policy tools. In particular, we first show that subsidizing savings alone improves welfare because it mitigates the under-saving problem i.e. inter-temporal allocation distortion. However, the optimal subsidy rate is not as high as in Krusell et al. (2010) because the savings subsidy amplifies the over-supply-of-labor problem, i.e. intra-temporal allocation distortion. Next, we find that labor income tax policy alone improves welfare because it mitigates the intra-temporal allocation distortion; however, its welfare gains are constrained by its adverse effects on savings. Finally, we demonstrate that a combination of capital and labor income taxation appears to be a more effective policy.

Keywords: Self-control; Consumption bias; Under-saving; Over-supply-of-labor; Taxation; Welfare; General equilibrium (search for similar items in EconPapers)
JEL-codes: D01 D91 H31 (search for similar items in EconPapers)
Date: 2018
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Working Paper: Temptation and Taxation with Elastic Labor (2014) Downloads
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