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Optimal Commodity Taxation with Moral Hazard and Unobservable Outcomes

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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 the reimbursement scheme. First, consumers are induced to take (forego) actions which increase (decrease) the likelihood of adverse outcomes (i.e., ex ante moral hazard). Second, reimbursement insurance creates 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 sufficiently strong complements to (substitutes for) the insured commodity. An example centered on cigarettes and medical insurance is presented.

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Authors and Affiliations

  1. Department of Economics, Saunders Hall, Room 515B, University of Hawaii, 2424 Maile Way, Honolulu, HI, 98822, USA and

    Gerard Russo

  2. Research Program, Population & Health Studies, Burns Hall, Room 2045, East-West Center, 1601 East-West Road, Honolulu, HI, 96848, USA

    Gerard Russo

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Russo, G. Optimal Commodity Taxation with Moral Hazard and Unobservable Outcomes. International Journal of Health Care Finance and Economics 3, 53–71 (2003). https://doi.org/10.1023/A:1023272032586

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