Pigou meets Mirrlees: On the irrelevance of tax distortions for the second-best Pigouvian tax

Bas Jacobs and Ruud de Mooij

Journal of Environmental Economics and Management, 2015, vol. 71, issue C, 90-108

Abstract: This paper extends the Mirrlees (1971) model of optimal income redistribution with optimal corrective taxes to internalize consumption externalities. Using general utility structures and exploring both linear and non-linear taxes, it is demonstrated that the optimal second-best tax on an externality-generating good should not be corrected for the marginal cost of public funds, since it equals one in the optimal tax system. In the optimum, distortions of income taxes are equal to marginal redistributional gains. If the government does not have access to a non-distortionary marginal source of finance, the marginal cost of public funds can be either larger or smaller than one depending on subjective preferences for income redistribution. The optimal second-best corrective tax is then either higher or lower than the Pigouvian level. The findings in this paper generalize and amend prior results based on representative-agent models, shedding new light on the weak double-dividend hypothesis, and on the welfare gains of recycling revenue from environmental taxes.

Keywords: Marginal cost of public funds; Optimal environmental taxation; Optimal redistribution; Externalities (search for similar items in EconPapers)
JEL-codes: D62 H21 H23 (search for similar items in EconPapers)
Date: 2015
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Citations: View citations in EconPapers (74)

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Working Paper: Pigou Meets Mirrlees: On the Irrelevance of Tax Distortions for the Second-Best Pigouvian Tax (2011)
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Persistent link: https://EconPapers.repec.org/RePEc:eee:jeeman:v:71:y:2015:i:c:p:90-108

DOI: 10.1016/j.jeem.2015.01.003

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