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Optimal second best taxation of addictive goods in dynamic general equilibrium


Bossi, Luca; Gomis-Porqueras, Pedro; & Kelly, David L. (2010). Optimal second best taxation of addictive goods in dynamic general equilibrium. University of Miami, Working Paper(0708).


In this paper we derive conditions under which optimal tax rates for addictive goods exceed tax rates for non-addictive consumption goods in 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 goes up.
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 the 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 unrelated to addiction itself, are nonetheless common among many addictive goods.


Reference Type

Journal Article

Year Published


Journal Title

University of Miami, Working Paper


Bossi, Luca
Gomis-Porqueras, Pedro
Kelly, David L.