Tax reform, unhealthy commodities and endogenous health.

Abstract

This paper explores how tax reforms with taxes on unhealthy commodities impact consumer behaviours and welfare when individual health is endogenised. We employ a dynamic general equilibrium model which includes both goods and health sectors. Although unhealthy commodities provide utility, they pose a detrimental effect on health. The analytical results show that the introduction of taxes on unhealthy commodities does not have direct effects on health in the steady state. However, based on our simulation results, with a revenue-neutral tax reform where labour income taxes are adjusted, the introduction of taxes on unhealthy commodities improves both health and welfare, but reduces leisure in the long run. On the other hand, a tax reform where capital income taxes are adjusted contributes to even higher welfare as both health and leisure improve. Our analysis may inform policy making decisions on taxation of unhealthy commodities when government can adjust pre-existing taxes.