Optimal Commodity Taxation
with Moral Hazard and Unobservable Outcomes
Gerard Russo
Friday, April 12, 2002
3:00 PM – 4:15 PM
Saunders 515
Abstract
The optimal public insurance-taxation scheme is derived for a model with unobservable outcomes. If the government can only observe aggregate commodity expenditures, reimbursement insurance is constrained-efficient. However, two distortions accompany. First, consumers are induced to take (forego) actions which increase (decease) the likelihood of adverse outcomes (i.e., “ex ante” moral hazard”). Second reimbursement insurance created a subsidy distortion (i.e., “ex post” moral hazard). “Ex ante” moral hazard calls for taxation (subsidization) of commodities which increase (decrease) the probability of adverse outcomes. The second distortion calls for taxation (subsidization) of commodities which are complements to (substitutes for) the insured commodity. An example centered on cigarettes and medical insurance is presented.