TY  - JOUR
AU  - Kenkel,Donald S.
AU  - Reed,Robert R.,III
AU  - Wang,Ping
TI  - Rational Addiction, Peer Externalities and Long Run Effects of Public Policy
JF  - National Bureau of Economic Research Working Paper Series
VL  - No. 9249
PY  - 2002
Y2  - October 2002
UR  - http://www.nber.org/papers/w9249
L1  - http://www.nber.org/papers/w9249.pdf
N1  - Author contact info:
Donald S. Kenkel
Department of Policy Analysis and Management
College of Human Ecology
Cornell University
Martha Van Rensselaer Hall
Ithaca, NY  14853-4401
Tel: 607/255-2594
Fax: 607/255-0799
E-Mail: dsk10@cornell.edu

Ping Wang
Department of Economics
Washington University in St. Louis
Campus Box 1208
One Brookings Drive
St. Louis, MO 63130-4899
Tel: 314/935-5632
Fax: 314/935-4156
E-Mail: pingwang@wustl.edu
AB  - The main purpose of this research is to understand the patterns of consumption of addictive goods, their economic and welfare consequences for society and the long-run effect of tax policy in a dynamic general equilibrium model of rational addiction. In contrast to prior research, we allow individuals to make their consumption decisions simultaneous with savings and labor supply. When addictive goods have a stronger habit formation effect (an addiction effect'), individuals choose to save less due to the anticipated adverse health consequences of addiction (a detrimental health effect'). This is particularly important since total savings pins down future productivity in the economy. We also consider the role of peer influence in the choice of addiction and find that more  peer pressure' raises addictive consumption, lowers savings and reduces productivity. In light of the various distortions associated with addiction, we conclude by studying the long-run effects of an excise tax on addictive goods. Our calibration exercises suggest that incorporating capital formation and peer effects in a model of rational addiction are crucial for the design of public policy. In particular, accounting for peer externalities increases the optimal sin tax rate by more than 50 percent.
ER  -