Scandinavian Working Papers in Economics
Working Papers in Economics,
University of Gothenburg, Department of Economics
No 204: The Importance of Habit Formation for Environmental Taxation
Åsa Löfgren () and Katarina Nordblom ()
Additional contact information
Åsa Löfgren: Department of Economics, School of Business, Economics and Law, Göteborg University, Postal: Box 640, SE 405 30 GÖTEBORG
Katarina Nordblom: Department of Economics, School of Business, Economics and Law, Göteborg University, Postal: Box 640, SE 405 30 GÖTEBORG
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.
Keywords: Optimal taxation; environment; habit formation; secondbest; myopia
18 pages, April 27, 2006
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