Time preferences
Economic rationale for consumption taxes
● Correct harmful effects on 3rd parties - Pigouvian tax
● Raise revenue
● Reduce consumption of goods with danger to health/wellbeing (sin goods)
○ Sugar tax of up to 24p per litre
Discounting and time preferences
● Decisions taken over time involve discounting due to:
○ Opportunity cost
○ Patience
○ The probability of reaching time period t
● We assume a constant discount rate - δ
○ A δ closer to 0 means you would prefer the money now
○ 𝑈(𝑥) = ∑𝑇𝑡=0 𝛿 𝑡 𝑢(𝑥𝑡 )
𝑥
○ If u(x)=x, x is worth 1−𝛿every year
Present bias
● People tend to overvalue immediate vs future rewards
● Present bias / hyperbolic discounting sees individuals put off costly activities
● Hyperbolic discounting implies 𝑢 = 𝑢0 + 𝛽𝛿𝑢1 + 𝛽𝛿 2 𝑢2
○ Creates a discontinuity between present and future payoffs
○ β<1 implies a present bias
○ β=1 - not biased
● Consumers have a present bias when consuming sin goods
○ Consumption benefits now but health costs later - irrational
● In the model, x (crisps) is a sin good and y (carrots) is a normal good
○ Can see the negative impact of the sin good in the future
● Sin goods can be taxed at a higher rate than the normal good
● If β=1, tax rates are equal - no present bias
● O’Donoghue and Rabin (2003) - trade-off between helping β<1 consumers
and hurting β=1 consumers
○ Larger effect on the β<1 consumer as they demand more
● Consumers vote for this tax because:
○ Sophisticates understand they have a lack of self-control and want a
commitment mechanism
○ Naifs believe they will be self-controlled in the future
Evaluation of sin taxes
Economic rationale for consumption taxes
● Correct harmful effects on 3rd parties - Pigouvian tax
● Raise revenue
● Reduce consumption of goods with danger to health/wellbeing (sin goods)
○ Sugar tax of up to 24p per litre
Discounting and time preferences
● Decisions taken over time involve discounting due to:
○ Opportunity cost
○ Patience
○ The probability of reaching time period t
● We assume a constant discount rate - δ
○ A δ closer to 0 means you would prefer the money now
○ 𝑈(𝑥) = ∑𝑇𝑡=0 𝛿 𝑡 𝑢(𝑥𝑡 )
𝑥
○ If u(x)=x, x is worth 1−𝛿every year
Present bias
● People tend to overvalue immediate vs future rewards
● Present bias / hyperbolic discounting sees individuals put off costly activities
● Hyperbolic discounting implies 𝑢 = 𝑢0 + 𝛽𝛿𝑢1 + 𝛽𝛿 2 𝑢2
○ Creates a discontinuity between present and future payoffs
○ β<1 implies a present bias
○ β=1 - not biased
● Consumers have a present bias when consuming sin goods
○ Consumption benefits now but health costs later - irrational
● In the model, x (crisps) is a sin good and y (carrots) is a normal good
○ Can see the negative impact of the sin good in the future
● Sin goods can be taxed at a higher rate than the normal good
● If β=1, tax rates are equal - no present bias
● O’Donoghue and Rabin (2003) - trade-off between helping β<1 consumers
and hurting β=1 consumers
○ Larger effect on the β<1 consumer as they demand more
● Consumers vote for this tax because:
○ Sophisticates understand they have a lack of self-control and want a
commitment mechanism
○ Naifs believe they will be self-controlled in the future
Evaluation of sin taxes
