The Importance of Habit Formation for Environmental Taxation

Åsa Löfgren and Katarina Nordblom ()

No 204, Working Papers in Economics from University of Gothenburg, Department of Economics

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 (search for similar items in EconPapers)
JEL-codes: D62 D91 H21 H23 (search for similar items in EconPapers)
Pages: 18 pages
Date: 2006-04-27
New Economics Papers: this item is included in nep-env, nep-pbe and nep-pub
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Citations: View citations in EconPapers (2)

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