Habit formation and labor supply

Cremer, Helmuth;De Donder, Philippe;Maldonado, Dario;Pestieau, Pierre
(2008) , 14 pages

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Authors
  • Cremer, HelmuthToulouse School of Economics (GREMAQ, IDEI and Institut universitaire de France), France.
    Author
  • De Donder, PhilippeToulouse School of Economics (GREMAQ-CNRS and IDEI), France.
    Author
  • Maldonado, DarioUniversidad del Rosario, Bogota, Columbia.
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  • Pestieau, PierreCREPP, HEC-Management School University of Liège; CORE, UCL
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Abstract
This paper shows that the combination of habit formation – present consumption creating additional consumption needs in the future – and myopia may explain why some retirees are forced to "unretire", i.e., unexpectedly return to work. It also shows that when myopia about habit formation leads to unretirement there is a case for government's intervention. In a first-best setting the optimal solution can be decentralized by a simple "Pigouvian" (paternalistic) consumption tax (along with suitable lump-sum taxes). In a second-best setting, when personalized lump-sum transfers are not available, consumption taxes may have conflicting paternalistic and redistributive effects. We study the design of consumption taxes in such a setting when myopic individuals differ in productivity.
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Cremer, H., De Donder, P., Maldonado, D., & Pestieau, P. (2008). Habit formation and labor supply (CORE Discussion Papers 2008/38). https://hdl.handle.net/2078.5/250088