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The Two-Part Instrument in a Second-Best World

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  • Don Fullerton
  • Ann Wolverton

Abstract

The standard theory that the first-best tax on pollution is equal to marginal environmental damages has been extended in two directions. First, many polluting activities are difficult to tax because they are not market transactions, and so recent papers have shown that the same effects can be achieved by use of a two-part instrument a tax on one market transaction such as output or income and a subsidy to a different market transaction that is a clean alternative to pollution. It is a generalization of a deposit-refund system. Second, a different literature concerns the second-best optimal pollution tax in the presence of other tax distortions. Here, we combine the two extensions by looking at the second-best two-part instrument (2PI). When government needs revenue, is the deposit larger and the rebate smaller? We find explicit solutions for each tax and subsidy in a general equilibrium model with other tax distortions, and we compare these to the rates in a first-best model. The tax-subsidy combination is explained in terms of a tax effect, an environmental effect, and a revenue effect. The model allows for flexible interpretation, to show various applications of the 2PI. We also discuss important caveats, cases where the 2PI may not be appropriate.

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Bibliographic Info

Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 10140.

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Date of creation: Dec 2003
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Publication status: published as Fullerton, Don and Ann Wolverton. "The Two-Part Instrument In A Second-Best World," Journal of Public Economics, 2005, v89(9-10,Sep), 1961-1975.
Handle: RePEc:nbr:nberwo:10140

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Citations

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Cited by:
  1. Katri Kosonen & Gaëtan Nicodème, 2009. "The role of fiscal instruments in environmental policy," Working Papers CEB 09-026.RS, ULB -- Universite Libre de Bruxelles.
  2. Ronnie Schöb, 2003. "The Double Dividend Hypothesis of Environmental Taxes: A Survey," Working Papers 2003.60, Fondazione Eni Enrico Mattei.
  3. Hilary Sigman & Sarah Stafford, 2010. "Management of Hazardous Waste and Contaminated Land," Departmental Working Papers 201008, Rutgers University, Department of Economics.
  4. Navajas, Fernando H. & Panadeiros, Monica & Natale, Oscar, 2011. "Environmentally Related Energy Taxes in Argentina, Bolivia and Uruguay," MPRA Paper 37829, University Library of Munich, Germany.
  5. Thomas Eichner & Rüdiger Pethig, 2007. "Pricing the Ecosystem and Taxing Ecosystem Services: A General Equilibrium Approach," CESifo Working Paper Series 1991, CESifo Group Munich.
  6. Ann Wolverton & Don Fullerton, 2000. "Two Generalizations of a Deposit-Refund Systems," American Economic Review, American Economic Association, vol. 90(2), pages 238-242, May.
  7. Thomas Eichner & Rüdiger Pethig, 2011. "Unilateral reduction of medium-term carbon emissions via taxing emissions and consumption," Volkswirtschaftliche Diskussionsbeiträge 152-11, Universität Siegen, Fakultät Wirtschaftswissenschaften, Wirtschaftsinformatik und Wirtschaftsrecht.
  8. Fabio Antoniou & Roland Strausz, 2014. "The Effectiveness of Taxation and Feed-in Tariffs," CESifo Working Paper Series 4788, CESifo Group Munich.
  9. Hiroaki Ino, 2010. "Optimal Environmental Policy for Waste Disposal and Recycling When Firms Are Not Compliant," Discussion Paper Series 50, School of Economics, Kwansei Gakuin University, revised Jan 2010.
  10. Christoph Heinzel & Thomas Winkler, 2011. "Economic functioning and politically pragmatic justification of tradable green certificates in Poland," Environmental Economics and Policy Studies, Society for Environmental Economics and Policy Studies - SEEPS, vol. 13(2), pages 157-175, June.
  11. Renan-Ulrich Goetz & Yolanda Martínez, 2013. "Nonpoint source pollution and two-part instruments," Environmental Economics and Policy Studies, Society for Environmental Economics and Policy Studies - SEEPS, vol. 15(3), pages 237-258, July.
  12. repec:dgr:uvatin:2007042 is not listed on IDEAS
  13. Arwin Pang & Daigee Shaw, 2011. "Optimal emission tax with pre-existing distortions," Environmental Economics and Policy Studies, Society for Environmental Economics and Policy Studies - SEEPS, vol. 13(2), pages 79-88, June.
  14. Kurtyka, Oliwia & Mahenc, Philippe, 2011. "The switching effect of environmental taxation within Bertrand differentiated duopoly," Journal of Environmental Economics and Management, Elsevier, vol. 62(2), pages 267-277, September.

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