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Michael Williams
 
''Simulations of fundamental tax reform with irrational households''
( 2005, Vol. 8 No.3 )
 
 
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.
 
 
Keywords:
JEL: H2 - Taxation, Subsidies, and Revenue: General
D1 - Household Behavior: General
 
Manuscript Received : Nov 03 2004 Manuscript Accepted : Jan 26 2005

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