Temptation and the efficient taxation of education and labor

Abstract

AbstractThis paper studies efficient tax policies in Ramsey's tradition when consumers face temptation and self control problems in intertemporal decision making. We embed the class of preferences developed by Gul and Pesendorfer into a simple two‐period life‐cycle model and show that education should be effectively subsidized if the elasticity of the earnings function is increasing in education and if temptation problems are sufficiently severe. By contrast, if temptation problems are not sufficiently severe, efficient education policy calls for taxing education. Moreover, efficient labor taxation calls for subsidizing qualified labor if the strength of temptation is sufficiently large.