The Welfare Effects of Environmental Taxation
Recent literature has investigated whether the welfare gains from environmental taxation are larger or smaller in a second-best setting than in a first-best setting. This question has mainly been addressed indirectly, by asking whether the second-best optimal environmental tax is higher or lower than the first-best Pigouvian rate. Even this indirect question has itself been approached indirectly, comparing the second-best optimal environmental tax to a proxy for its first-best value, marginal social damage (MSD). On closer examination, however, MSD becomes ambiguously defined and variable in a second-best setting making it an unreliable proxy for the Pigouvian rate. Given these observations, the current analysis reevaluates these welfare questions and finds that when compared directly to its first-best value, the second-best optimal environmental tax generally rises with increased revenue requirements. Even in cases where the second-best environmental tax is lower than its first-best value, the welfare gains may be greater than in a first-best setting. These results suggest that the marginal fiscal benefit (revenue recycling effect) exceeds the marginal fiscal cost (tax base effect) over a range of environmental tax rates that, for benchmark models, extends above the first-best Pigouvian rate. These findings reinforce the intuition that environmental policy complements rather than competes with the provision of other public goods.
KeywordsDouble dividend Excess burden Optimal environmental tax Pigouvian rate Revenue recycling Second-best Tax base effect Tax interaction effect
Unable to display preview. Download preview PDF.
- Auerbach AJ, Hines JR Jr (2002) Taxation and economic efficiency. In: Auerbach AJ, Feldstein M (eds) Handbook of public economics, vol 3. Elsevier, AmsterdamGoogle Scholar
- Boadway R, Tremblay J (2008) Pigouvian taxation in a Ramsey world. Asia Pac J Account Econ 15(3): 183–204Google Scholar
- Bovenberg AL, de Mooij RA (1994) Environmental levies and distortionary taxation. Am Econ Rev 94(4): 1085–1089Google Scholar
- Bovenberg AL, Goulder LH (1996) Optimal environmental taxation in the presence of other taxes: general equilibrium analysis. Am Econ Rev 86(4): 985–1000Google Scholar
- Bovenberg AL, Goulder LH (2002) Environmental taxation and regulation. In: Auerbach AJ, Feldstein M (eds) Handbook of public economics, vol 3, pp 1471–1545Google Scholar
- Browning EK (1987) On the marginal welfare cost of taxation. Am Econ Rev 77(1): 11–23Google Scholar
- Fullerton D (1997) Environmental levies and distortionary taxation: comment. Am Econ Rev 87(1): 245–251Google Scholar
- Howarth RB (2005) The present value criterion and environmental taxation: the sub-optimality of first-best decision rules. Land Econ 81(3): 321–336Google Scholar
- Orosel GO, Schöb R (1996) Internalizing externalities in second-best tax systems. Public Finance 51: 242–257Google Scholar
- Schöb R (1996) Evaluating tax reforms in the presence of externalities. Oxford Econ Papers 48(4): 537–555Google Scholar
- Viscusi WK (1993) The value of risks to life and health. J Econ Lit 31(4): 1912–1946Google Scholar