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Internalizing Externalities in Second-Best Tax Systems

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  • Gerhard Orosel
  • Ronnie Schöb

Abstract

We analyze the analytical structure of optimal taxation of polluting and non-polluting goods in a second-best world where lump-sum taxes are infeasible. After deriving the environmental tax rate which exactly internalizes the external effect, we show how to separate the analysis of second-best optimal environmental taxes from the analysis of the tax structure which minimizes the excess burden. This separation reveals that standard results of optimal taxation essentially carry over to economies with externalities. Our approach clarifies the controversy regarding the relation between the first-best Pigovian tax rate on polluting goods and the optimal tax rate in a second-best world.

Suggested Citation

  • Gerhard Orosel & Ronnie Schöb, 1995. "Internalizing Externalities in Second-Best Tax Systems," CESifo Working Paper Series 101, CESifo.
    • Handle: RePEc:ces:ceswps:_101
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    Cited by:

    1. Jukka Pirttilä & Ronnie SchöB, 1999. "Redistribution and Internalization: The Many-Person Ramsey Tax Rule Revisited," Public Finance Review, , vol. 27(5), pages 541-560, September.
    2. William Jaeger, 2011. "The Welfare Effects of Environmental Taxation," Environmental & Resource Economics, Springer;European Association of Environmental and Resource Economists, vol. 49(1), pages 101-119, May.

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