Smoking Decisions and the Welfare Economics of Myopia
Time-inconsistency poses a challenge to traditional Paretian welfare analysis, because it considers agents who cannot agree about what is best for themselves. This makes it difficult for society to decide upon policies that make such individuals better off. Many proposed policy interventions, such as sin taxes for smokers, overeaters, and other addicts, suffer from this problem by making a time-inconsistent individual better off at some points in his life, but worse off at others. We explore whether it is generally possible to make time-inconsistent individuals better off at all points in time, in spite of their changing preferences. We show that taxes coupled with upfront payments can accomplish this. Intuitively, time-inconsistent agents demand future taxes, but dislike current taxes. A solution is for the present indi- vidual to compensate his future self for facing a tax, by means of an upfront payment. The feasibility of this scheme depends on the ability to monitor an individual’s consumption and on incentive-compatible contracts. We explore possibilities for monitoring consumption in the case of smoking, and the construction of incentive-compatible contracts.