Taxing and Regulating Vices*

• Date: 01 April 2020
• Published date: 01 April 2020
• Author: Anna Maria C. Menichini,Maria Grazia Romano,Giovanni Immordino
• DOI: http://doi.org/10.1111/sjoe.12334

Scand. J. of Economics 122(2), 622–647, 2020

DOI: 10.1111/sjoe.12334

Taxing and Regulating Vices*

Giovanni Immordino

University of Naples Federico II, 80122 Naples, Italy

giovanni.immordino@unina.it

Anna Maria C. Menichini

University of Salerno, 84084 Fisciano (SA), Italy

amenichini@unisa.it

Maria Grazia Romano

University of Salerno, 84084 Fisciano (SA), Italy

maromano@unisa.it

Abstract

Westudy the optimal taxation and regulation of sin goods – goods that are enjoyable to consume

but also create future negative health consequences – within a setting in which individuals are

time-inconsistent (and thus consume too much), regulation makes the consumption of sin goods

lesspleasurable, and taxation involves administrative and compliance costs. In contrast to previous

literature, we find that regulation can be beneficial even when correctivetaxes are available and

individuals are homogeneous.Moreover, despite the inefficiencies associated with the use of both

instruments, the consumption of the sin good might fall short of the first best. The results are

robust to consumers’ heterogeneity.

Keywords: Consumption restrictions; hyperbolic preferences; sin goods

JEL classification:D03; H21; L51

I. Introduction

Recent economic literature has investigated the effect of sin taxes, which

are taxes on goods that are enjoyable to consume but create negative future

health consequences (Gruber and Koszegi, 2004; O’Donoghue and Rabin,

2006). This body of literature has provided strong arguments for taxation

to correct not only the externalities associated with the consumption of

the sin good, but also the “internalities” generated by consumers’ time-

inconsistency (i.e., overconsumption of sin goods). However, it has failed

*We thank Alberto Bennardo, Emilio Calvano, Marco Ottaviani, Antonio Rosato, and two

anonymous referees, as well as the participants of several seminars and conferences for their

insightful comments which greatly improved the paper.The authors are research fellows at the

Center for Studies in Economics and Finance (CSEF). All errors are our own.

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The editors of The Scandinavian Journal of Economics 2018.

G. Immordino,A. M. C. Menichini, and M. G. Romano 623

to observe that there are inefficiencies associated with taxation in terms

of administrative and compliance costs.1,2Moreover, besides taxation, the

government can try to affect directly and/or indirectly the demand for

sin goods through regulatory measures. Bans and restrictions on junk

food, smoking, alcohol purchase, and gambling are but a few examples

of consumption regulation that are used widely by many countries and

that have proven to be effective means of reducing the consumption of sin

goods.

Despite the widespread reliance of policy-makers on both measures,

there has not yet been an investigation in the economics literature into the

joint impact of tax and regulatory measures on the consumption of sin

goods.

We incorporate the inefficiencies associated with taxation into a model

in which the consumption choice of identical agents with self-control

problems may be affected by regulatory measures. We focus on a simple

quasi-linear economy in which there is a composite good and a sin good.

Regulatory measures affect the agents’ utility through a reduction in the

actual immediate benefit from consuming the sin good. For example, by

restricting the choice of freedom and constraining addicted consumers to

smoke in uncomfortable situations (e.g., outside in the cold), clean air

regulations can generate a large immediate disutility. Similarly, bans on

high-fat foods such as crisps in schools, by obliging agents to postpone

consumption, impose a reduction in the immediate utility from junk food

consumption. Within this setting, we analyze three cases: two in which each

instrument (i.e., taxation and regulation) is used in isolation, and a third in

which both instruments are used together.

When only taxation is used, our first result is that the optimal tax

is positive, provided the inefficiency associated with it is not too large.

Moreover, it can be higher or lower than the first best, where first-best

taxation is the level that induces the agent to consume the first-best level

of the sin good, depending on the price elasticity of demand. Finally, the

1Administrative costs are incurred by the tax authority for collecting taxes and enforcing fiscal

laws, while compliance costs are incurred by taxpayers in order to complywith tax obligations.

As to their magnitude, for the former a recent OECD study reported an estimate of roughly 0.5

percent of net revenuecollection for the US, with a median of about 1 percent for OECD countries

(OECD,2011). For the latter, a study by PricewaterhouseCoopers (2015) for 189 countries across

the world reported that the number of hours spent complying with consumption tax (sales and

VAT) amounts to an averageof 99 hours, with figures of 55 hours for European Union/European

Free Trade Association states and 60 hours for North America. For an extensive survey of the

literature on the relevance of tax operating costs, see Evans (2003).

2The literature on externality has already highlighted administrative costs as a possible

disadvantage of corrective taxes (e.g., Shavell,2011).

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The editors of The Scandinavian Journal of Economics 2018.