Tax Reform, Consumption Habits, Capital Accumulation, and Welfare

This paper investigates the impact of tax reforms on capital accumulation and welfare in both a model without habits (benchmark model) and a model with habits. In the benchmark model, the examined tax reforms generally lead to higher welfare. In contrast, in the model with habits the same tax changes may imply lower levels of welfare (efficiency). The paper highlights the danger that policy analysis not accounting for habits, may fail to predict the correct mathematical sign of the impact of tax reform on savings, growth, and welfare