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The Importance of Habit Formation for Environmental Taxation

Abstract
We analyze how habit formation affects optimal environmental taxation, when consumption of a habitual good causes a negative external effect on the environment. In a simple two-period model, we show that optimal taxation is still Pigouvian, where tax rates equal marginal damage in each period. However, the magnitudes of the tax rates are affected by habit formation. Using simulations we show that since consumption of the habitual good increases over time, so does the optimal tax rate, implying a higher tax rate in period two than in period one. The discrepancy increases in habitual strength. Given the development of the tax rates over time we discuss the welfare loss from imposing a secondbest environmental tax and its relation to habitual strength. Further, we analyze how optimal taxation changes if we relax the assumption of time-consistency
University
Göteborg University. School of Business, Economics and Law
URI
http://hdl.handle.net/2077/2710
Collections
  • Working papers
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gunwpe0204.pdf (189.6Kb)
Date
2006
Author
Nordblom, Katarina
Löfgren, Åsa
Keywords
Optimal taxation; environment; habit formation; secondbest; myopia
Publication type
Report
ISSN
1403-2465
Series/Report no.
Working Papers in Economics, nr 204
Language
en
Metadata
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