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Rational Addiction, Peer Externalities and Long Run Effects of Public Policy

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  • Donald S. Kenkel
  • Robert R. Reed III
  • Ping Wang

Abstract

The main purpose of this research is to understand the patterns of consumption of addictive goods, their economic and welfare consequences for society and the long-run effect of tax policy in a dynamic general equilibrium model of rational addiction. In contrast to prior research, we allow individuals to make their consumption decisions simultaneous with savings and labor supply. When addictive goods have a stronger habit formation effect (an addiction effect'), individuals choose to save less due to the anticipated adverse health consequences of addiction (a detrimental health effect'). This is particularly important since total savings pins down future productivity in the economy. We also consider the role of peer influence in the choice of addiction and find that more peer pressure' raises addictive consumption, lowers savings and reduces productivity. In light of the various distortions associated with addiction, we conclude by studying the long-run effects of an excise tax on addictive goods. Our calibration exercises suggest that incorporating capital formation and peer effects in a model of rational addiction are crucial for the design of public policy. In particular, accounting for peer externalities increases the optimal sin tax rate by more than 50 percent.

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Bibliographic Info

Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 9249.

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Date of creation: Oct 2002
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Handle: RePEc:nbr:nberwo:9249

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  1. Kenkel, D.S., 1988. "Health Behavior, Health Knowledge, And Schooling," Papers 10-88-3, Pennsylvania State - Department of Economics.
  2. Cook, Philip J. & Moore, Michael J., 1994. "This Tax's for You: The Case for Higher Beer Taxes," National Tax Journal, National Tax Association, vol. 47(3), pages 559-73, September.
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Cited by:
  1. William H Greene & Mark N Harris & Preety Srivastava & Xueyan Zhao, 2013. "Econometric Modelling of Social Bads," Bankwest Curtin Economics Centre Working Paper series WP1305, Bankwest Curtin Economics Centre (BCEC), Curtin Business School.
  2. Pierre Pestieau & Gregory Ponthiere, 2012. "Myopia, regrets, and risky behaviors," International Tax and Public Finance, Springer, vol. 19(2), pages 288-317, April.
  3. Brian Krauth, 2004. "Peer and selection effects on youth smoking in California," HEW 0408002, EconWPA.
  4. Sarah Brown & Mark N Harris & Preety Srivastava, 2013. "Modelling Illegal Drug Participation in Australia," Bankwest Curtin Economics Centre Working Paper series WP1303, Bankwest Curtin Economics Centre (BCEC), Curtin Business School.

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