Tax reform when commuting has demerit properties

Abstract People spend a lot of their time commuting. Research in health economics indicates that spending time in traffic has long run adverse mental and physical health consequences. Literature suggests that, when making decisions about commuting, the individual might underestimate these long run consequences and take them insufficiently into consideration. For this reason, we argue that commuting has demerit properties: an internality is involved. From a social welfare perspective, apart from the demerit aspect, commuting is also associated with an externality. If commuters underestimate the impact on their welfare of commuting, this aggravates also the externality. We develop a formal model incorporating both the externality and the internality aspects of commuting, and its interplay. From the model we derive clearly two types of externalities: direct and indirect ones, both of which need internality correction. Then we incorporate both these considerations into marginal costs of funds (MCF) formulae. MCF are calculated for all U.S. states using the American Time Use Survey. We show that the demerit considerations cause rank switches in over half of the States and that an increase in the taxes on commuting accompanied by a decrease in other taxes benefits social welfare.