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The Welfare Effects of Environmental Taxation

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  • William Jaeger

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    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

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    Bibliographic Info

    Article provided by European Association of Environmental and Resource Economists in its journal Environmental and Resource Economics.

    Volume (Year): 49 (2011)
    Issue (Month): 1 (May)
    Pages: 101-119

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    Handle: RePEc:kap:enreec:v:49:y:2011:i:1:p:101-119

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    Web page: http://www.springerlink.com/link.asp?id=100263

    Related research

    Keywords: Double dividend; Excess burden; Optimal environmental tax; Pigouvian rate; Revenue recycling; Second-best; Tax base effect; Tax interaction effect;

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    Cited by:
    1. Per G. Fredriksson & Xenia Matschke, 2014. "Trade Liberalization and Environmental Taxation in Federal Systems," CESifo Working Paper Series 4717, CESifo Group Munich.
    2. Geir H. Bjertnæs & Marina Tsygankova & Thomas Martinsen, 2012. "The double dividend in the presence of abatement technologies and local external effects," Discussion Papers 691, Research Department of Statistics Norway.
    3. Bjertnæs, Geir H. & Tsygankova, Marina & Martinsen, Thomas, 2013. "Norwegian climate policy reforms in the presence of an international quota market," Energy Economics, Elsevier, vol. 39(C), pages 147-158.

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