A Policy Lesson from an Overlapping Generations Model of Habit Persistence
This paper analyzes the implication of habit persistence on the effects of tax policy. It shows that within the framework of an OLG economy with production, habit persistence generally increases savings (and steady state capital intensity), a result previously shown only for OLG exchange economies. Using an OLG economy with productive capital that considers habit persistence, an intensely-discussed policy issue is addressed: Does the introduction of a consumption tax foster capital accumulation? The answer the model gives is simple and striking. Contrary to the conclusion often drawn in the analysis of this issue, the model shows that because of habit persistence effects consumption taxation can result in a lessening of capital accumulation.
Department of Economics
JEL Nos: D11, D91, H31