Optimal tax mix with merit goods

Abstract

This paper deals with optimal taxation in a two-class economy with two private commodities and labour. We derive optimal nonlinear income and linear commodity taxes in the presence of merit goods. We formulate merit good arguments via a pathology of individual choice. We assume weak separability between consumption and leisure and show that the standard optimal tax results are modified due to merit good considerations. We first find a subsidy on the merit good. Secondly, optimal income marginal tax rates are also shown to dioeer from the standard literature: it is positive on high-ability individuals and on low-ability individuals it is ambiguous because of a dampening eoeect due to merit good considerations. Finally, we derive the effective marginal tax rates.