Conspicuous Consumption and Overlapping Generations

This paper investigates household decisions, and optimal taxation in an overlapping generations model in which individual utility depends on a weighted average of consumption of ones peers --- a ``keeping up with the Joneses'' consumption externality. In contrast to representative agent economies, the consumption externality \emph{generally} affects steady state savings and growth rates. The nature of the externality's impact, however, critically depends on the rate at which labor productivity declines with age. For a (strongly enough) declining labor productivity (or when people gradually retire), the consumption externality \emph{lowers} the steady state propensity to consume out of total wealth. The opposite holds for a constant labor productivity. The market economy can be decentralized by a (reverse) unfunded social security system if the rate of labor productivity decline is high (low). In contrast to previous results, the \emph{optimal} steady state capital income tax is zero, in spite of the consumption externality.