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Optimal Environmental Policy, Public Goods and Labor Markets over the Business Cycle

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  • Anna Grodecka
  • Karlygash Kuralbayeva

Abstract

This paper studies the design of optimal fiscal policy in a real business cycle model with distortionary taxes and a climate change externality. Governments face the dual task of internalizing environmental externalities and raising revenues to finance the provision of public goods, including public capital. At their disposal governments have access to two tax instruments: tax on emissions and labor tax. We find that a tax on labor is an efficient instrument to finance public spending and facilitate the adjustment of the economy to the temporary improvement in productivity. Therefore, labor tax is cut in the model. Tax on emissions follows a distinct pattern depending on whether the potential economic expansion in response to a positive productivity shock is strong or weak: it is procyclical in the model that features public capital and is countercyclical in the models with public consumption only. The model implies that by restraining or boosting expansion in the short-run, the optimal carbon tax policy can help policy makers reconcile short-term concerns over economic growth with longer-term risks from climate change. The welfare gains from such short-run policies are non-negligible and can amount to USD 121.9bn or 0.7% of the US GDB.

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Bibliographic Info

Paper provided by Oxford Centre for the Analysis of Resource Rich Economies, University of Oxford in its series OxCarre Working Papers with number 137.

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Date of creation: 2014
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Handle: RePEc:oxf:oxcrwp:137

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Keywords: public finance; public goods; business cycles; distortionary taxes; environmental policy;

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  1. Mikhail Golosov & Aleh Tayvinski & Matthew Weinzierl, 2010. "Preference Heterogeneity and Optimal Capital Income Taxation," STICERD - Public Economics Programme Discussion Papers 04, Suntory and Toyota International Centres for Economics and Related Disciplines, LSE.
  2. Rogerson, Richard & Wallenius, Johanna, 2009. "Micro and macro elasticities in a life cycle model with taxes," Journal of Economic Theory, Elsevier, vol. 144(6), pages 2277-2292, November.
  3. Fischer, Carolyn & Heutel, Garth, 2013. "Environmental Macroeconomics: Environmental Policy, Business Cycles, and Directed Technical Change," Working Papers 13-2, University of North Carolina at Greensboro, Department of Economics.
  4. V. V. Chari & Lawrence J. Christiano & Patrick J. Kehoe, 1993. "Optimal Fiscal Policy in a Business Cycle Model," NBER Working Papers 4490, National Bureau of Economic Research, Inc.
  5. Rausch, Sebastian, 2013. "Fiscal consolidation and climate policy: An overlapping generations perspective," Energy Economics, Elsevier, vol. 40(S1), pages S134-S148.
  6. Smulders, J.A. & Gradus, R.H.J.M., 1993. "Pollution abatement and long-term growth," Discussion Paper 1993-73, Tilburg University, Center for Economic Research.
  7. Garth Heutel, 2012. "How Should Environmental Policy Respond to Business Cycles? Optimal Policy under Persistent Productivity Shocks," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 15(2), pages 244-264, April.
  8. Schmitt-Grohé, Stephanie & Uribe, Martín, 2004. "Optimal Simple and Implementable Monetary and Fiscal Rules," CEPR Discussion Papers 4334, C.E.P.R. Discussion Papers.
  9. Zhu, Xiaodong, 1992. "Optimal fiscal policy in a stochastic growth model," Journal of Economic Theory, Elsevier, vol. 58(2), pages 250-289, December.
  10. Kuralbayeva, Karlygash, 2013. "Optimal fiscal policy and different degrees of access to international capital markets," Journal of Development Economics, Elsevier, vol. 103(C), pages 336-352.
  11. Juin-Jen Chang & Jhy-Hwa Chen & Jhy-Yuan Shieh & Ching-Chong Lai, 2009. "Optimal Tax Policy, Market Imperfections, and Environmental Externalities in a Dynamic Optimizing Macro Model," Journal of Public Economic Theory, Association for Public Economic Theory, vol. 11(4), pages 623-651, 08.
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