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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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References

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  1. Cremer, Helmuth & Gahvari, Firouz & Ladoux, Norbert, 1998. "Externalities and optimal taxation," Journal of Public Economics, Elsevier, vol. 70(3), pages 343-364, December.
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Citations

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Cited by:
  1. 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.
  2. Stéphane Gauthier & Guy Laroque, 2008. "Separability and public finance," IFS Working Papers W08/07, Institute for Fiscal Studies.
  3. Hoffmann, Florian & Inderst, Roman & Moslener, Ulf, 2013. "Taxing Externalities under Financing Constraints," MPRA Paper 53855, University Library of Munich, Germany.
  4. Louis Kaplow, 2008. "Optimal Policy with Heterogeneous Preferences," NBER Working Papers 14170, National Bureau of Economic Research, Inc.
  5. James R. Hines Jr., 2007. "Taxing Consumption and Other Sins," Journal of Economic Perspectives, American Economic Association, vol. 21(1), pages 49-68, Winter.
  6. Raj Chetty & Emmanuel Saez, 2007. "An Agency Theory of Dividend Taxation," NBER Working Papers 13538, National Bureau of Economic Research, Inc.
  7. Russo, Antonio, 2012. "Pricing of Transport Networks, Redistribution and Optimal Taxation," TSE Working Papers 12-353, Toulouse School of Economics (TSE).
  8. 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.

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