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Optimal Second Best Taxation of Addictive Goods

  • Luca Bossi

    ()

    (Department of Economics, University of Miami)

  • Pedro Gomis-Porqueras

    ()

    (Department of Economics, University of Miami)

  • David L. Kelly

    ()

    (Department of Economics, University of Miami)

In this paper we derive conditions under which optimal tax rates for addictive goods exceed tax rates for non-addictive consumption goods in an environment where exogenous government spending cannot be nanced with lump sum taxes. Standard static models that consider revenue raising and externalities predict taxing addictive goods at a rate far in excess of that observed in the data. In contrast, our results indicate that, given reasonable parameter values for the strengths of tolerance for the addictive good, homogeneity of the addiction function and the elasticity of substitution, the tax rates are likely to be smaller than the ones implied by the static case. This is the case because high current tax rates on addictive goods tend to reduce future tax revenues, by making households less addicted in the future. Finally, we consider features of addictive goods such as complementarity to leisure that, while unrelated to addiction itself, are nonetheless common among some addictive goods. In general, such e ects are weaker in our dynamic setting since if taxing addictive goods has strong positive revenue e ects today, then taxing goods has a strong o setting e ect on future tax revenues.

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File URL: http://moya.bus.miami.edu/~dkelly/papers/addtax9_26_07.pdf
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Paper provided by University of Miami, Department of Economics in its series Working Papers with number 0708.

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Length: 34 pages
Date of creation: 16 Jun 2007
Date of revision:
Publication status: Forthcoming: Under Review
Handle: RePEc:mia:wpaper:0708
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