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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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number
9249.
Length: Date of creation: Oct 2002 Date of revision: Handle: RePEc:nbr:nberwo:9249
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Find related papers by JEL classification: D91 - Microeconomics - - Intertemporal Choice and Growth - - - Intertemporal Consumer Choice; Life Cycle Models and Saving H20 - Public Economics - - Taxation, Subsidies, and Revenue - - - General
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References listed on IDEAS Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
Frank J. Chaloupka & Kenneth E. Warner, 1999.
"The Economics of Smoking,"
NBER Working Papers
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Chaloupka, Frank J. & Warner, Kenneth E., 2000.
"The economics of smoking,"
Handbook of Health Economics,
in: A. J. Culyer & J. P. Newhouse (ed.), Handbook of Health Economics, edition 1, volume 1, chapter 29, pages 1539-1627
Elsevier.
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