Economics at your fingertips  

The case for subsidizing harm: constrained and costly Pigouvian taxation with multiple externalities

Daniel Jaqua () and Daniel Schaffa ()
Additional contact information
Daniel Jaqua: George Washington University
Daniel Schaffa: University of Richmond

International Tax and Public Finance, 2022, vol. 29, issue 2, No 6, 408-442

Abstract: Abstract Many activities are subsidized despite generating negative externalities. Examples include needle exchanges and energy production subsidies. We explain this phenomenon by developing a model in which the policymaker faces constraints or costs. We highlight three examples. First, it may be optimal to subsidize a harmful activity if the policymaker cannot set the first-best tax on an externally harmful substitute. Second, it may be optimal to subsidize a harmful production process if the activity mix at lower levels of output uses more harmful activities than the activity mix at higher levels of output. Third, it may be optimal to subsidize a harmful activity if there is a large administrative cost associated with taxing a harmful substitute. We also show how the functional form of the cost of administering a Pigouvian tax affects the optimal tax. When administrative cost is a function of only tax rates, the policymaker should tax each activity. However, an increase in the tax presents a trade-off: lower externality but higher administrative cost. A subsidy may be optimal for some externally harmful activities. When administrative cost is a function of only activity levels, it may not be optimal to tax every activity. If it is optimal to tax each activity, the policymaker should set the tax equal to the externality plus the marginal administrative cost. If it is not optimal to tax every activity, the complementarity between activities comes into play, and it may be optimal to subsidize externally harmful activities.

Keywords: Administrative cost; Corrective taxation; Externality; Optimal taxation; Optimal tax systems; Pigouvian taxation; Second best; H21; H23 (search for similar items in EconPapers)
Date: 2022
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (1)

Downloads: (external link) Abstract (text/html)
Access to full text is restricted to subscribers.

Related works:
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link:

Ordering information: This journal article can be ordered from
http://www.springer. ... ce/journal/10797/PS2

DOI: 10.1007/s10797-021-09670-5

Access Statistics for this article

International Tax and Public Finance is currently edited by Ronald B. Davies and Kimberly Scharf

More articles in International Tax and Public Finance from Springer, International Institute of Public Finance Contact information at EDIRC.
Bibliographic data for series maintained by Sonal Shukla () and Springer Nature Abstracting and Indexing ().

Page updated 2024-03-09
Handle: RePEc:kap:itaxpf:v:29:y:2022:i:2:d:10.1007_s10797-021-09670-5