Economic Inquiry (ISSN 0095-2583) Vol. 39, No. 3, July 2001, 379–395 © Western Economic Association International A THEORY OF TIME PREFERENCE PHILIP A. TROSTEL and GRANT A. TAYLOR ∗ This article proposes that people generally prefer present consumption to future consumption because their expected utility from consumption (eventually) falls as their mental and physical abilities (eventually) decline with age. Moreover, contrary to the ubiquitous intertemporal formulation with a constant rate of time preference and contrary to three recent theories of time preference that predict decreasing discounting as people age, this article asserts that discounting increases over the life cycle. This hypothesis is supported by data from the Panel Study of Income Dynamics as well as evidence from numerous previous studies. (JEL D91) I. INTRODUCTION Despite the almost universal assumption of time preference in models of intertempo- ral choice, an adequate explanation of why people discount the future has not been pro- vided. 1 Olsen and Bailey (1981) make a con- vincing case for positive time preference by contradiction (i.e., without time preference models of intertemporal choice do not yield predictions consistent with observed behav- ior), but they do not explain why individuals would rationally discount the future. 2 Three ∗ For helpful comments we are grateful to Paul Chen, Mike Ellis, Emily Lawrance, Andrew Oswald, the referees, and seminar participants at Australian National University, University College London, Uni- versity of East Anglia, Federal Reserve Bank of Dallas, Hong Kong University of Science and Technology, Keele University, Kent State University, University of New South Wales, University of Texas at Arlington, Univer- sity of Texas at Austin, and University of Warwick. Trostel: Associate Professor, Department of Eco- nomics, and Research Associate, Margaret Chase Smith Center for Public Policy, University of Maine, 5715 Coburn Hall, Orono, ME 04469-5715. Phone 1-207-581-1646, Fax 1-207-581-1266, E-mail philip.trostel@um.7.maine.edu Taylor: Lecturer, Division of Applied Economics, Nanyang Technological University, 50 Nanyang Ave., Singapore. Phone +65-790-5691, Fax +65-792-4217, E-mail agataylo@delta2.ntu.edu.sg 1. Friedman (1969), for example, argues that none of the “reasons for discounting the future relative to the present  appeals to me strongly as a satisfactory expla- nation. Yet I must confess that I have found no other” (21–23). This led Stigler and Becker (1977) to conclude “that the assumption of time preference impedes the explanation of life cycle variations in the allocation of resources, the secular growth in real incomes, and other phenomena” (89). 2. Indeed, many of the initial writers on the subject (e.g., Rae [1905], Jevons [1965], B¨ ohm-Bawerk [1959], recent studies have attempted to provide the explanation. Rogers (1994) argues that soci- eties that discount the future (at a rate of about 2%) will be the long-run survivors in an evolutionary fitness situation. 3 Posner (1995) argues that discounting occurs because indivi- duals have “multiple selves,” that is, “people are weighting their present consumption far more heavily than their future consumption... [because] the present self and the future self are, in some meaningful sense, separate per- sons” (92). Becker and Mulligan (1997) argue that discounting occurs because of a ratio- nal “defective recognition of future utilities” (730). But, as will be shown, these three the- ories are inconsistent with empirical evidence on consumption over the life cycle in at least one important aspect. This article constructs and empirically sup- ports a new theory of time preference. The hypothesis is that people do not have an intrinsic preference for present consumption Marshall [1920], Pigou [1932], Ramsey [1928], Fisher [1930], and Harrod [1948]) argued that discounting is to some extent irrational. 3. On the other hand, Hansson and Stuart (1990) contend that societies that do not have an intrinsic pref- erence for current consumption will be the evolutionary winners. ABBREVIATIONS AFS: Annual Food Standard CES: Consumer Expenditure Survey CPI: Consumer Price Index PSID: Panel Study of Income Dynamics 379