Moral hazard models with hidden asset markets are useful to study several interesting problems such as unemployment insurance, income taxation, executive compensation, or human capital policies. Without the use the first-order condition approach, these models easily become non-tractable.In this paper, we provide sufficient conditions for the validity of the first-order approach for twoperiod dynamic moral hazard problems where the agent can save and borrow secretly. To ensure that the agent's problem is jointly concave in effort and asset decisions when facing the optimal contract, we build on the concept of log-convexity. Since this property, unlike convexity, is preserved under multiplication, we are able to separate the assumptions on the distribution function from the assumptions on the agent's preferences, even though the interaction between these two is important for the agent's incentives. We show that the first-order approach is valid if the following conditions hold: i) the agent has nonincreasing absolute risk aversion utility (NIARA), ii) the output technology has monotone likelihood ratios (MLR), and iii) the distribution function of output is log-convex in effort (LCDF). Moreover, under the above three conditions, the optimal contract is monotone in output. We also investigate a few possibilities of relaxing these requirements.

Standard-Nutzungsbedingungen:Die Dokumente auf EconStor dürfen zu eigenen wissenschaftlichen Zwecken und zum Privatgebrauch gespeichert und kopiert werden.Sie dürfen die Dokumente nicht für öffentliche oder kommerzielle Zwecke vervielfältigen, öffentlich ausstellen, öffentlich zugänglich machen, vertreiben oder anderweitig nutzen.Sofern die Verfasser die Dokumente unter Open-Content-Lizenzen (insbesondere CC-Lizenzen) zur Verfügung gestellt haben sollten, gelten abweichend von diesen Nutzungsbedingungen die in der dort genannten Lizenz gewährten Nutzungsrechte. Optimal Taxation in a Habit Formation Economy Terms of use: Documents in EconStor may AbstractWe study implications of habit formation for optimal taxation. First, we show that taxation problems with habit formation can be analyzed using dynamic programming techniques. Second, we derive optimal labor and savings wedges for habit formation preferences. We show that habit formation counteracts the conventional Mirrleesian distortions and calls for subsidies to labor supply and savings. We demonstrate that the theoretical results are quantitatively important: in a stylized life-cycle model, average labor and savings wedges fall by more than one third compared to time-separable references. Third, we exploit the analogy between habit formation and durable consumption to study the taxation of durable and nondurable commodities.JEL-Code: D820, E210, H210.

This article proposes a dynamic Mirrleesian theory of commodity taxation in the presence of durable goods. A uniform taxation across all goods is suboptimal even when the consumption preferences are separable from labor. If the consumption utility function is strictly concave and durable stocks are adjustable without friction, durable investment should be taxed at a higher rate than the purchase of nondurable goods. With adjustment frictions, the wedge on durable investment depends on substitution effects between durable and nondurable consumption and can be positive or negative. An application suggests that housing investment should face higher tax rates than regular consumption.

A series of empirical studies has documented that job search behavior depends on the financial situation of the unemployed. Starting from this observation, we ask how unemployment insurance policy should take the individual financial situation into account. We use a quantitative model with a realistically calibrated unemployment insurance system, individual consumption-saving decision and moral hazard during job search to answer this question. We find that the optimal policy provides unemployment benefits that increase with individual assets. By implicitly raising interest rates, asset-increasing benefits encourage self-insurance, which facilitates consumption smoothing during unemployment but does not exacerbate moral hazard for job search. Asset-increasing benefits also have desirable properties from a dynamic perspective, because they emulate key features of the dynamics of constrained efficient allocations. We find welfare gains from introducing asset-increasing benefits that are substantial and amount to 1.5% of consumption when comparing steady states and 0.8% of consumption when taking transition costs into account. More generous replacement rates or benefits targeted to asset-poor households, by contrast, have a negative effect on welfare. JEL: E21, H21, J65