Optimal Taxation on Mixed Diamond Goods: Implications for Private Car Ownership in China

Abstract

The 'diamond effect' exists when a consumer's utility depends on the exchange value, not just on the intrinsic consumption effects of the good. Yew-Kwang Ng has discussed the optimal tax on a pure 'diamond' good. This paper extends Ng's model to cover mixed diamond goods. It uses three mathematical models to show that the optimal tax on a mixed diamond good with both intrinsic and diamond effects depends on the proportion of the diamond effect. The result may explain the violation of the Ramsey Rule in practice, and may be used to formulate private car taxes in China. Copyright 2004 Blackwell Publishing Asia Pty Ltd