Tax reform when commuting has demerit properties

People spend a lot of their time commuting. From a social welfare perspective, commuting is associated with an externality related to traffic and an internality related to health. A social planner should take both into consideration when planning tax reform. Research in health economics indicates that spending time in traffic has long run adverse mental and physical health consequences. This 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. If commuters underestimate the impact on their welfare of commuting (i.e. they are myopic), 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.