Research

In this paper we derive conditions under which optimal tax rates for addictive goods exceed tax rates for non-addictive consumption goods within a rational addiction framework where exogenous government spending cannot be financed with lump sum taxes. We reexamine classic results on optimal commodity taxation and find a rich set of new findings. Two dynamic effects exist. First, households anticipating higher future addictive tax rates reduce current addictive consumption, so they will be less addicted when the tax rate increases. Therefore, addictive tax revenue falls prior to the tax increase. Surprisingly, the optimal tax rate on addictive goods is generally decreasing in the strength of tolerance, since strong tolerance strengthens this tax anticipation effect. Second, high current tax rates on addictive goods make households less addicted in the future, affecting all future tax revenues in a way which depends on how elasticities are changing over time. Classic results on uniform commodity taxation emerge as special cases when elasticities are constant and the addiction function is homogeneous of degree one. Finally, we also study features of addictive goods such as complementarity to leisure that, while not directly related to the definition of addiction, are nonetheless properties many addictive goods display.

JEL Classification: E61, H21, H71.

Keywords: Addictive goods; dynamic optimal taxation; habit formation; Ramsey model.

Optimal Tax Rules and Addictive Consumption (with Paul Calcott and Vladimir Petkov) Journal of Economic Dynamics and Control, Vol. 37(5) pp. 984-1000, 2013.

Abstract: This paper studies implementation of the social optimum in a model of addictive consumption. We consider corrective taxes that address inefficiencies due to negative externalities, imperfect competition, and self-control problems. Our setup allows us to evaluate how such taxes are affected by (i) market power, and (ii) a requirement for implementation to be time consistent. Together, these features can imply significantly lower taxes. We provide a general characterization of the optimal tax rule and illustrate it with two examples.

JEL Classification: D11, D43, L13, H21.

Keywords: Dynamic externalities, internalities, addiction, optimal taxation, time consistent implementation.

Income Inequality, Mobility, and the Welfare State: A Political Economy Model (with Gulcin Gumus) Macroeconomic Dynamics, Vol. 17 (Special Issue Number 6) pp. 1198-1226 (lead article), 2013.

Abstract: In this paper, we set up a three-period stochastic overlapping generations model to analyze the implications of income inequality and mobility for demand for redistribution and social insurance. We model the size of two different public programs under the welfare state. We investigate bi-dimensional voting on the tax rates that determine the allocation of government revenues among transfer payments and old-age pensions. We show that the coalitions formed, of income inequality and mobility.the resulting political equilibria, and the demand for redistribution crucially depend on the level of income inequality and mobility.

JEL Classification: D72, H53, H55.

Keywords: Redistribution, mobility, inequality, structure induced equilibrium.

Monopoly, Time Consistency, and Dynamic Demands (with Vladimir Petkov) Journal of Industry, Competition and Trade, Vol. 13(3) pp. 339-359, 2013.

Abstract: This paper examines monopolistic behavior in a framework with dynamic demands. We show that time consistent output and pricing policies yield different equilibrium outcomes in terms of profits and welfare. In a simple two period model, we find that pricing policies impose less restrictive constraints on a producer of addictive goods, allowing him to attain higher equilibrium profits. In contrast, a durable goods producer is better off implementing output policies. We study the effect of instrument selection on the strategic properties of the monopolist's intra-personal game. Intertemporal substitutabilities imply that current and future prices are strategic complements, while current and future output levels may be strategic substitutes. Intertemporal complementarities reverse the strategic properties of these instruments.