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The Welfare Effects of Environmental Taxation

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https://ir.library.oregonstate.edu/concern/articles/9593tv72j

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  • 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.
  • Keywords: Revenue recycling, Second-best, Tax interaction effect, Pigouvian rate, Excess burden, Double dividend, Optimal environmental tax, Tax base effect
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  • Jaeger, W. K. (2011). The welfare effects of environmental taxation. Environmental and Resource Economics, 49(1), 101-119. doi:10.1007/s10640-010-9426-x
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  • 49
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  • 1
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