Dynamic Inefficiency in an Overlapping Generation Economy with Pollution and Health Costs

We analyze an overlapping generations model in which pollution arises, in an accumulatively way, from production. Householders do not care directly about the environment, but pollution leads them to incur health costs when they are elderly. We show that the presence of pollution means that the economy more likely to be dynamically inefficient. For these cases we analyze two kinds of tax scheme: one based on production taxes and the other based on capital and wage taxes. We show how to design both schemes to put the economy into the golden rule allocation. We also show that under the production tax scheme young and elderly agents pay less taxes (or receive more transfers) than under the production tax system.