Threshold preferences and the environment

In this article we study the implication of thresholds in preferences. To model this we extend the basic model of John and Pecchenino (1994) by allowing the current level of environmental quality to have a discrete impact on how an agent trades off future consumption and environmental quality. Thus, we endogenize the semi-elasticity of utility based on a step function. We find that for low (high) thresholds, environmental quality converges to a low (high) steady state. For intermediate levels it converges to a stable p-cycle, with environmental quality being asymptotically bounded below and above by the low and high steady state. As policy implications we study shifts in the threshold. Costless shifts of the threshold are always worthwhile. If it is costly to change the threshold, then it is worthwhile to change the threshold if the threshold originally was sufficiently low. Lump-sum taxes lead to a development trap and a proportional income tax should be preferred.