Sin licenses revisited

Abstract

We analyze personalized regulation in the form of sin licenses (O'Donoghue and Rabin 2003, 2005, 2007) to correct the distortion in the consumption of a harmful good when consumers suffer from varying degrees of self-control problems. We take into account demand uncertainty, which generates a trade-off between flexibility and the commitment provided by sin licenses. We also account for the possibility that consumers may trade the sin good in a secondary market, which partially erodes the commitment power of sin licenses. We show that if sophisticated consumers are allowed to choose any general, individualized pricing-scheme for sin goods, they will choose a system of sin licenses. Nevertheless, sin licenses do not implement the first best in our general setting. Under certain conditions, social welfare will increase if linear taxation of sin goods is supplemented by a system of voluntary sin licenses; but welfare might decrease if the linear tax was replaced by sin licenses.