Optimal Sin Taxes
Department of Economics
Department of Economics
University of California, Berkeley
March 6, 2006
We investigate ‘‘sin taxes’’ on unhealthy items, such as fatty foods, that people may (by their own reckoning) consume too much of. We employ a standard optimal-taxation framework, but replace the standard assumption that all consumers have 100% self control with an assumption that some consumers may have some degree of self-control problems. We show that imposing taxes on unhealthy items and returning the proceeds to consumers can generally improve total social surplus. Because such taxes counteract over-consumption by consumers with self-control problems while at the same time they naturally redistribute income to consumers with no self-control problems (who consume less), such taxes can even create Pareto improvements. Finally, we demonstrate with some simple numerical examples that even if the population exhibits relatively few self-control problems, optimal taxes can still be large. Acknowledgments: We thank Robert Hall and Robert Barro for helpful discussions of a related shorter paper presented at the AEA meetings in January 2003. For helpful comments, we thank Jonathan Gruber and an anonymous referee, and also Steve Coate, Botond Koszegi, Emmanuel Saez, and seminar participants at Harvard, Yale, Stanford, Cornell, Vanderbilt, North Carolina State, the USC Behavioral Public Finance Conference, the 2003 Association of Public Economic Theory Conference at Duke, the 2004 ASSA meetings, and the Cornell-LSE-MIT Conference on Behavioral Public and Development Economics. For research assistance, we thank Christoph Vanberg and Chris Cotton. For financial support, we thank the National Science Foundation (grants SES-0214043 and SES-0214147), and Rabin thanks the Russell Sage and MacArthur Foundations. Mail: Ted O’Donoghue / Department of Economics / Cornell University / 414 Uris Hall / Ithaca, NY 14853-7601. Matthew Rabin / Department of Economics / 549 Evans Hall #3880 / University of California, Berkeley / Berkeley, CA 94720-3880. E-mail: email@example.com and firstname.lastname@example.org. CB handles: ‘‘Puck Boy’’ and ‘‘Game Boy’’. Web pages: http://www.people.cornell.edu/pages/edo1/ and http://emlab.berkeley.edu/users/rabin/.‘‘Never eat more than you can lift.’’ – Miss Piggy 1. Introduction
We investigate the welfare effects of ‘‘sin taxes’’ on unhealthy items, such as fatty foods, that people may (by their own reckoning) consume too much of. The standard economic approach to taxation a priori assumes that there is no such ‘‘over-consumption’’, and hence the only reasons to tax commodities are to raise revenue, to correct externalities, or to redistribute wealth. If, however, people do exhibit such over-consumption — due to self-control problems or some other error — then the standard calculus of optimal taxation does not necessarily hold. 1
We employ a standard framework to study optimal commodity taxation, but we replace the standard assumption that all consumers have 100% self control with an assumption that some consumers may have some degree of self-control problems — formalized as a time-inconsistent preference for immediate gratification. Using a social-welfare function that puts equal weight on all individuals, we show that imposing taxes on unhealthy items and returning the proceeds to consumers can generally improve social surplus. Moreover, we find that such taxes can even create Pareto improvements — in other words, such taxes need not involve helping people with self-control problems to the detriment of fully rational people. Finally, we demonstrate with some simple numerical examples that even if the prevalence of self-control problems in the population is relatively small, optimal sin taxes can still be large.
In Section 2, we develop a framework to analyze optimal commodity taxation when agents might have self-control...
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