Abstract
We characterize the first-best earnings subsidy when agents are heterogeneous with respect to present-biased preferences and cognitive skills. When agents’ health and human capital biased allocations affect not only welfare but also their labor earnings, a single subsidy corrects for agents’ mistaken decisions. We highlight two novel features of paternalistic interventions: the effects of agents’ decisions on the economy’s supply side, through future productivity, and the role of cognitive skills on individual’s optimal trade-off between human capital accumulation and leisure. We compare this optimal subsidy to an alternative policy package.
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