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Title: Habit Formation and Labour Supply

Author(s): Helmuth Cremer, Philippe De Donder, Darío Maldonado and Pierre Pestieau

Publication Date: April 2008

Keyword(s): Habit formation, Myopia and Unretiring

Programme Area(s): Public Economics

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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Bibliographic Reference

Cremer, H, De Donder, P, Maldonado, D and Pestieau, P. 2008. 'Habit Formation and Labour Supply'. London, Centre for Economic Policy Research. https://cepr.org/active/publications/discussion_papers/dp.php?dpno=6776