Lifestyle taxes in the presence of profit shifting

Abstract

The consumption of unhealthy products generates significant externalities in terms of increased future health care costs to society. Lifestyle taxes are attracting increasing attention as a measure by which to discourage over-consumption and correct such externalities. This paper focuses on the trade-off that governments face in setting a lifestyle tax when the producer of the taxed good is a multinational which may engage in profit-shifting activities. In the absence of profit shifting, if governments do care about corporate tax revenue, the optimal lifestyle tax is always lower than the marginal health care cost. We show that, by shrinking the corporate tax base, profit shifting has the interesting side effect of helping to close the gap between the lifestyle tax and the marginal health care cost.