Dynamic Corrective Taxes with Time-Varying Salience

Gilbert, B and J Graff Zivin, “Dynamic Corrective Taxes with Time-Varying Salience,” Journal of Environmental Economics and Management, 103 (2020): 102356.

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Economies across the globe are becoming increasingly cashless and many payment systems have become automated, driving a temporal wedge between consumption and payment and generally making the costs of consumption intermittently salient. Since this inconsistent price salience alters demand elasticities, it is a particular concern for goods that generate externalities and the price-based policies deployed to address them. This paper derives optimal dynamic corrective taxes for suboptimal and persistent consumption decisions. These taxes depend on the agent’s ability to commit to a future consumption path. We also character-size a second-best constant tax and the excess burden from time-invariant tax rates. When calibrated to U.S. residential electricity consumption, the model shows that the second-best constant tax is more than twice the marginal external cost of carbon emissions.