Paternalism and Tax Competition

When consumers make mistakes, the government may wish to use paternalistic taxation as a corrective measure. We analyse the extent to which tax competition undermines the feasibility of paternalistic taxation. We show that the paternalistic component of a tax on a harmful good is reduced when there is cross-border shopping, but it does not disappear altogether. In a model with tax competition between two countries, only one of which has a paternalistic objective, we show that a minimum tax rate requirement can be Pareto improving despite the divergence in policy objectives. Tax harmonization, however, reduces welfare in the non-paternalistic country.