Temptation and Taxation with Elastic Labor

Chung Tran

ANU Working Papers in Economics and Econometrics from Australian National University, College of Business and Economics, School of Economics

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 rather than one-dimensional ones. 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, Kuruscu and Smith (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.

JEL-codes: D01 D91 H31 (search for similar items in EconPapers)
Pages: 41 pages
Date: 2014-06
New Economics Papers: this item is included in nep-pbe and nep-pub
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Journal Article: Temptation and taxation with elastic labor (2018)
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Persistent link: https://EconPapers.repec.org/RePEc:acb:cbeeco:2014-617

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