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Simulations of fundamental tax reform with irrational households

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  • Michael Williams

    (University of Saint Thomas)

Abstract

Dynamic tax models have been devised to examine the effects of fundamental tax reform replacing the current U. S. federal tax system with a national retail sales tax. These models impose a constant and positive rate of time preference on households, in the tradition of the rational, time-consistent consumer. Evidence suggests, however, that households are impatient and time-inconsistent, questioning the validity of a constant rate of time preference. This paper modifies an existing dynamic life-cycle tax model so that it can incorporate this time inconsistency, using a construct known as hyperbolic discounting. We find a significant change in the model's predictions of the effects of fundamental tax reform, including smaller short term losses and smaller long term gains, when the standard assumption of a constant rate of time preference is replaced with the hyperbolic discounting assumption.

Suggested Citation

  • Michael Williams, 2005. "Simulations of fundamental tax reform with irrational households," Economics Bulletin, AccessEcon, vol. 8(3), pages 1-11.
  • Handle: RePEc:ebl:ecbull:eb-04h20013
    as

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    References listed on IDEAS

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    More about this item

    JEL classification:

    • H2 - Public Economics - - Taxation, Subsidies, and Revenue
    • D1 - Microeconomics - - Household Behavior

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