Optimal Policies for Sin Goods and Health Care: Tax or Subsidy?

In this paper we examine the optimal policies for sin goods and health care in a two-period economy. Individuals are myopic in the sense that they undervalue the utilities of future consumption and health quality. When investing in health care in the second period, individuals who have previously made myopic decisions may persist in their shortsighted consumption plans (persistent error) or recognize their mistakes (dual self). We show that, for persistent-error myopes, the first-best policy mix requires a subsidy on savings and a tax on sin goods. The health care should be taxed (subsidized) if the degree of myopia concerning future consumption is larger (smaller) than that concerning health quality. For dual-self myopes, the optimal policy for sin goods can be either a tax or a subsidy, depending on the relative degrees of myopia and the property of the health quality function.