Behavioral Earmarking and Capital Drag: The Macroeconomics of Green Subsidies

Rawat, Rohit (2026): Behavioral Earmarking and Capital Drag: The Macroeconomics of Green Subsidies.

Abstract

Standard fiscal theory treats green subsidies as income transfers whose allocation is governed by rational optimization. We embed Thalerian mental accounting into a two-period overlapping generations model, formalizing subsidy earmarking as a binding psychological constraint. The model yields a closed-form result: earmarked transfers elevate the marginal propensity to consume the targeted good while crowding out aggregate savings. When the subsidy is sufficiently large relative to the preference weight on standard consumption, the behavioral friction generates a permanently lower steady-state capital stock relative to the neoclassical benchmark—a hidden long-run cost of green fiscal policy. We derive the precise threshold condition and show that Pigouvian carbon taxation dominates earmarked subsidies in the capital-accumulation dimension.

• Item Type: MPRA Paper
• Language: English
• Keywords: mental accounting, green subsidies, overlapping generations, capital accumulation, behavioral macroeconomics
• Subjects: D - Microeconomics > D9 - Intertemporal Choice > D91 - Intertemporal Household Choice ; Life Cycle Models and Saving; E - Macroeconomics and Monetary Economics > E6 - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook > E62 - Fiscal Policy; H - Public Economics > H2 - Taxation, Subsidies, and Revenue > H23 - Externalities ; Redistributive Effects ; Environmental Taxes and Subsidies

References

Goulder, L. H. and Schneider, S. H. (1999). Induced technological change, crowding out and the attractiveness of CO2 abatement policies. Resource and Energy Economics, 21(3-4):211-253.

Hastings, J. and Shapiro, J. M. (2013). Fungibility and consumer choice: Evidence from commodity price shocks. The Quarterly Journal of Economics, 128(4):1449-1498.

Kooreman, P. (2000). The labeling effect of a child benefit system. American Economic Review, 90(3):571-583.

Laibson, D. (1997). Golden eggs and hyperbolic discounting. The Quarterly Journal of Economics, 112(2):443-478.

Thaler, R. H. (1999). Mental accounting matters. Journal of Behavioral Decision Making, 12(3):183-206.