Time-Inconsistency and Welfare

Jay Bhattacharya, Stanford
Darius Noshir Lakdawalla, RAND

Abstract

Self-control devices, such as rehabilitation programs, group commitment, and informal fines, can make time-inconsistent smokers better off. Health economists have used this result to argue in favor of cigarette taxes that restrain smoking. However, taxes alone are not Pareto-improving overall, because they benefit today's smoker at the expense of her future selves, who have less demand for self-control. We suggest an alternative class of taxation policies that provide self-control and benefit a smoker at every point in life. Smokers could be allowed to purchase smoking licenses' when they start to smoke, and in exchange commit their future selves to face compensated cigarette taxes. We show that this scheme which could be made voluntary improves the welfare of current and future smokers, generates positive revenue for the government, and can be made incentive-compatible. Similar schemes can also be envisioned to address problems of time-inconsistency in other contexts.