Choosing between imperfect proxies for a corrective tax

Abstract

Choices are sometimes distorted by internalities or externalities. This paper considers a setting in which the distortion cannot be taxed directly, and asks how a policymaker should choose a proxy variable to tax instead. We derive a criterion for when one proxy should be preferred to another, and consider a range of factors with implications for this criterion. These factors are (i) sensitivity to the tax rate, (ii) how accurately the taxed variable approximates the distorted variable, (iii) susceptibility to offsetting behavior, and (iv) consumer heterogeneity. Our analysis is illustrated with a comparison between ad valorem and volumetric taxes on sugar-sweetened beverages.