The Welfare Effects of Environmental Taxation

William Jaeger ()

Environmental & Resource Economics, 2011, vol. 49, issue 1, 119 pages

Abstract: 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. Copyright Springer Science+Business Media B.V. 2011

Keywords: Double dividend; Excess burden; Optimal environmental tax; Pigouvian rate; Revenue recycling; Second-best; Tax base effect; Tax interaction effect (search for similar items in EconPapers)
Date: 2011
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Citations: View citations in EconPapers (15)

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DOI: 10.1007/s10640-010-9426-x

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