Habit formation and the pareto-efficient provision of public goods

Abstract

This paper examines the implications of habit formation in private and public goods consumption for the Pareto-efficient provision of public goods, based on a two-period model with nonlinear taxation. Under weak leisure separability, and if the public good is a flow-variable such that the government directly decides on the level of the public good in each period, habit formation leads to a modification of the policy rule for public good provision if, and only if, the degrees of habituation differ for private and public good consumption. By contrast, if the public good supply is time-invariant, the presence of habit formation generally alters the policy rule for public good provision.