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Revenue-Raising vs. Other Approaches to Environmental Protection: The Critical Significance of Pre-Existing Tax Distortions

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  • Lawrence H. Goulder
  • Ian W. H. Parry
  • Dallas Burtraw

Abstract

This paper examines the choice between revenue-raising and non-revenue-raising instruments for environmental protection in a second-best setting with pre- existing factor taxes. We find that interactions with pre-existing taxes influence the costs of regulation and seriously militate against pollution abatement policies that do not raise revenue. If the marginal environmental benefits from pollution reductions are below a certain threshold value, any amount of pollution abatement through non-revenue-raising (NRR) policies like emissions quotas is efficiency-reducing. Under conditions approximating S02 emissions from electric power plants in the U.S., efficiency gains vanish if marginal environmental benefits are below $109 per ton and an NRR policy is employed. These results are largely independent of the size of the regulated sector relative to the overall economy and stem from two underlying effects. The tax-interaction effect is the adverse impact in factor markets arising from reductions in after-tax returns to factors associated with the higher production costs caused by environmental regulation. This effect leads to significantly higher efficiency costs than what would apply in a first-best world with no pre-existing taxes. Revenue-raising regulations (taxes) enjoy a revenue-recycling effect that offsets much of the tax-interaction effect, but non-revenue-raising regulations (quotas) enjoy no such offset.For any target level of emissions reduction, the gross efficiency costs of quotas are higher than those of revenue-raising policies.. To the extent that government regulations of international trade or agricultural production raise the costs of output and thus reduce real factor returns, they generate much higher social costs than indicated by partial equilibrium analyses.

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Bibliographic Info

Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 5641.

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Date of creation: Jun 1996
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Publication status: published as Goulder, Lawrence H., Ian W. H. Parry and Dallas Burtraw. "Revenue-Raising Versus Other Approaches To Environmental Protection: The Critical Significance Of Preexisting Tax Distortions," Rand Journal of Economics, 1997, v28(4,Winter), 708-731.
Handle: RePEc:nbr:nberwo:5641

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  1. Bovenberg, A.L. & Ploeg, F. van der, 1992. "Environmental policy, public finance and the labour market in a second-best world," Discussion Paper, Tilburg University, Center for Economic Research 1992-43, Tilburg University, Center for Economic Research.
  2. Revesz, Richard L. & Stavins, Robert N., 2007. "Environmental Law," Handbook of Law and Economics, Elsevier, Elsevier.
  3. Alan J. Auerbach, 1982. "The Theory of Excess Burden and Optimal Taxation," NBER Working Papers 1025, National Bureau of Economic Research, Inc.
  4. Ng, Yew-Kwang, 1980. "Optimal Corrective Taxes or Subsidies When Revenue Raising Imposes an Excess Burden," American Economic Review, American Economic Association, American Economic Association, vol. 70(4), pages 744-51, September.
  5. Charles L. Ballard & Don Fullerton, 1993. "Distortionary Taxes and the Provision of Public Goods," NBER Working Papers 3506, National Bureau of Economic Research, Inc.
  6. Parry Ian W. H., 1995. "Pollution Taxes and Revenue Recycling," Journal of Environmental Economics and Management, Elsevier, vol. 29(3), pages S64-S77, November.
  7. Lawrence Goulder, 1995. "Environmental taxation and the double dividend: A reader's guide," International Tax and Public Finance, Springer, Springer, vol. 2(2), pages 157-183, August.
  8. Bovenberg, A.L. & Goulder, L.H., 1996. "Optimal environmental taxation in the presence of other taxes: General equilibrium analyses," Open Access publications from Tilburg University urn:nbn:nl:ui:12-73560, Tilburg University.
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  11. Burtraw Dallas & Harrington Winston & Krupnick Alan J. & Freeman III A. Myrick, 1995. "Optimal Adders for Environmental Damage by Public Utilities," Journal of Environmental Economics and Management, Elsevier, vol. 29(3), pages S1-S19, November.
  12. Ballard, Charles L & Shoven, John B & Whalley, John, 1985. "General Equilibrium Computations of the Marginal Welfare Costs of Taxes in the United States," American Economic Review, American Economic Association, American Economic Association, vol. 75(1), pages 128-38, March.
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  14. Browning, Edgar K., 1994. "The non-tax wedge," Journal of Public Economics, Elsevier, Elsevier, vol. 53(3), pages 419-433, March.
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  16. Parry, Ian W. H., 1997. "Environmental taxes and quotas in the presence of distorting taxes in factor markets," Resource and Energy Economics, Elsevier, Elsevier, vol. 19(3), pages 203-220, August.
  17. Portney, Paul R, 1990. "Economics and the Clean Air Act," Journal of Economic Perspectives, American Economic Association, American Economic Association, vol. 4(4), pages 173-81, Fall.
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  19. Terkla, David, 1984. "The efficiency value of effluent tax revenues," Journal of Environmental Economics and Management, Elsevier, vol. 11(2), pages 107-123, June.
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