Notes on Habit Formation and Socially Optimal Growth

The interaction between habit formation and pollution-type ex-ternalities modi\u85es the social optimum through discount e¤ects and elasticity e¤ects. If the substitution elasticity does not exceed unity, both e¤ects reduce optimal consumption and capital in the long run, and the optimal capital-income tax increases with the relative impor-tance of habits. Similar results hold with high elasticity if the relative importance of habits is su ¢ ciently high