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Should Benefit–Cost Analyses Take Account of General Equilibrium Effects?

In: Research in Law and Economics

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  • V. Kerry Smith
  • Jared C. Carbone

Abstract

This paper demonstrates the importance of general equilibrium (GE) feedback effects inside and outside markets for the measurement of the efficiency costs of taxes in a distorted economy. Our specific focus is on the changes in environmental amenities that can result from pollution externalities generated from production activities. Even when amenities are under three percent of virtual income, the error in the GE approximations of the welfare effects of new taxes with pre-existing distortions can increase threefold. The nature of the link between the source of the external effects influencing amenities and the changes in amenity services can alter the conclusions one would make about the merits of an intervention based on benefit–cost analyses.

Suggested Citation

  • V. Kerry Smith & Jared C. Carbone, 2007. "Should Benefit–Cost Analyses Take Account of General Equilibrium Effects?," Research in Law and Economics, in: Research in Law and Economics, pages 247-272, Emerald Group Publishing Limited.
    • Handle: RePEc:eme:rlwezz:s0193-5895(07)23011-8
    DOI: 10.1016/S0193-5895(07)23011-8
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