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Optimal Control of Externalities in the Presence of Income Taxation

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  • Louis Kaplow

Abstract

A substantial literature examines second-best environmental policy, focusing particularly on how the Pigouvian directive that marginal taxes should equal marginal external harms needs to be modified in light of the preexisting distortion due to labor income taxation. Additional literature is motivated by the possibility that distributive concerns should amend the internalization prescription. It is demonstrated, however, that simple first-best rules %u2013 unmodified for labor supply distortion or distribution %u2013 are correct in a natural, basic formulation of the problem. Specifically, setting all commodity taxes equal to marginal harms (and subsidies equal to marginal benefits) can generate a Pareto improvement. Likewise, a marginal reform in the direction of the first-best can yield a Pareto improvement. For other reforms, a simple efficiency test characterizing when a Pareto improvement is possible is offered. Qualifications and explanations for the substantial departure from results in previous work are also elaborated.

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Bibliographic Info

Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 12339.

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Date of creation: Jun 2006
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Handle: RePEc:nbr:nberwo:12339

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  1. Kaplow, Louis, 2006. "On the undesirability of commodity taxation even when income taxation is not optimal," Journal of Public Economics, Elsevier, vol. 90(6-7), pages 1235-1250, August.
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  3. Emmanuel Saez, 2002. "Direct or Indirect Tax Instruments for Redistribution: Short-run versus Long-run," NBER Working Papers 8833, National Bureau of Economic Research, Inc.
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  23. Louis Kaplow, 2004. "On the (Ir)Relevance of Distribution and Labor Supply Distortion to Government Policy," Journal of Economic Perspectives, American Economic Association, vol. 18(4), pages 159-175, Fall.
  24. Emmanuel Saez, 2000. "The Desirability of Commodity Taxation under Non-Linear Income Taxation and Heterogeneous Tastes," NBER Working Papers 8029, National Bureau of Economic Research, Inc.
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Cited by:
  1. James R. Hines Jr., 2007. "Taxing Consumption and Other Sins," Journal of Economic Perspectives, American Economic Association, vol. 21(1), pages 49-68, Winter.
  2. Louis Kaplow, 2008. "Optimal Policy with Heterogeneous Preferences," NBER Working Papers 14170, National Bureau of Economic Research, Inc.
  3. Hoffmann, Florian & Inderst, Roman & Moslener, Ulf, 2013. "Taxing Externalities under Financing Constraints," MPRA Paper 53855, University Library of Munich, Germany.
  4. Bas Jacobs & Ruud A. de Mooij, 2011. "Pigou Meets Mirrlees: On the Irrelevance of Tax Distortions for the Second-Best Pigouvian Tax," CESifo Working Paper Series 3342, CESifo Group Munich.
  5. Raj Chetty & Emmanuel Saez, 2007. "An Agency Theory of Dividend Taxation," NBER Working Papers 13538, National Bureau of Economic Research, Inc.
  6. Stéphane Gauthier & Guy Laroque, 2009. "Separability and public finance," Post-Print hal-00731132, HAL.
  7. Claus Thustrup Kreiner & Nicolaj Verdelin, 2008. "Optimal Provision of Public Goods: A Synthesis," EPRU Working Paper Series 08-05, Economic Policy Research Unit (EPRU), University of Copenhagen. Department of Economics.
  8. Russo, Antonio, 2012. "Pricing of Transport Networks, Redistribution and Optimal Taxation," TSE Working Papers 12-353, Toulouse School of Economics (TSE).

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