Optimal Taxation of Internalities: The Role of Market Incentives

28 Pages Posted: 17 Oct 2016 Last revised: 10 Nov 2016

See all articles by Andrew Whitten

Andrew Whitten

U.S. Department of the Treasury - Office of Tax Analysis (OTA)

Date Written: November 2016

Abstract

This paper analyzes the optimal taxation of goods when consumers fail to maximize their own utility, imposing internalities on themselves. This can happen due to imperfect information, cognitive bias, or lack of willpower, among other causes. I relax two ubiquitous assumptions found in other work on this topic by studying imperfect competition and the incentive firms have to de-bias consumers. Contrary to standard results, I find that (i) internality correction, even if costless, is not always desirable; (ii) optimal tax rates are generally not equal to marginal internalities; and (iii) firm de-biasing incentives attenuate the optimal internality tax or subsidy.

Keywords: Cognitive bias, imperfect competition, internality, internality tax, market failure, optimal taxation

JEL Classification: D03, D43, D61, H21, H23, H32

Suggested Citation

Whitten, Andrew, Optimal Taxation of Internalities: The Role of Market Incentives (November 2016). Available at SSRN: https://ssrn.com/abstract=2852436 or http://dx.doi.org/10.2139/ssrn.2852436

Andrew Whitten (Contact Author)

U.S. Department of the Treasury - Office of Tax Analysis (OTA) ( email )

1500 Pennsylvania Ave., N.W.
Washington, DC 22203
United States

HOME PAGE: http://rawhitten.com

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