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Taxing Externalities under Financing Constraints

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  • Hoffmann, Florian
  • Inderst, Roman
  • Moslener, Ulf

Abstract

We consider an economy where production generates externalities, which can be reduced by additional firm level expenditures. This requires firms to raise outside financing, leading to deadweight loss due to a standard agency problem vis-à-vis outside investors. Policy is constrained as firms are privately informed about their marginal cost of avoiding externalities. We first derive the optimal linear pollution tax, which is strictly lower than the Pigouvian tax for two reasons: First, higher firm outside financing creates additional deadweight loss; second, through redistributing resources in the economy, a higher tax reduces average productive efficiency. We analyze various instruments that achieve a more efficient allocation, in particular, nonlinear pollution taxes, which can no longer be implemented through a tradable permit scheme alone, and grants tied to loans, which are frequently observed in practice.

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Paper provided by University Library of Munich, Germany in its series MPRA Paper with number 53855.

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Date of creation: Aug 2013
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Handle: RePEc:pra:mprapa:53855

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Keywords: Optimal taxation; financing constraints; externalities;

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References

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  1. Boyer, M. & Laffont, J.J., 1995. "Environmental Risks and Bank Liability," Cahiers de recherche 9501, Centre interuniversitaire de recherche en économie quantitative, CIREQ.
  2. Robin Boadway & Jean-François Tremblay, 2003. "Public Economics and Startup Entrepreneurs," CESifo Working Paper Series 877, CESifo Group Munich.
  3. Diamond, Peter A & Mirrlees, James A, 1971. "Optimal Taxation and Public Production II: Tax Rules," American Economic Review, American Economic Association, vol. 61(3), pages 261-78, June.
  4. Pitchford, Rohan, 1995. "How Liable Should a Lender Be? The Case of Judgment-Proof Firms and Environmental Risk," American Economic Review, American Economic Association, vol. 85(5), pages 1171-86, December.
  5. Mirrlees, James A, 1971. "An Exploration in the Theory of Optimum Income Taxation," Review of Economic Studies, Wiley Blackwell, vol. 38(114), pages 175-208, April.
  6. Tirole, Jean, 2008. "From Pigou to Extended Liability: On the Optimal Taxation of Externalities under Imperfect Financial Markets," IDEI Working Papers 503, Institut d'Économie Industrielle (IDEI), Toulouse.
  7. Casey Rothschild & Florian Scheuer, 2011. "Optimal Taxation with Rent-Seeking," NBER Working Papers 17035, National Bureau of Economic Research, Inc.
  8. Seade, J. K., 1977. "On the shape of optimal tax schedules," Journal of Public Economics, Elsevier, vol. 7(2), pages 203-235, April.
  9. N. Gregory Mankiw & Matthew Weinzierl, 2009. "The Optimal Taxation of Height: A Case Study of Utilitarian Income Redistribution," NBER Working Papers 14976, National Bureau of Economic Research, Inc.
  10. Guesnerie, Roger & Laffont, Jean-Jacques, 1984. "A complete solution to a class of principal-agent problems with an application to the control of a self-managed firm," Journal of Public Economics, Elsevier, vol. 25(3), pages 329-369, December.
  11. Seade, Jesus, 1982. "On the Sign of the Optimum Marginal Income Tax," Review of Economic Studies, Wiley Blackwell, vol. 49(4), pages 637-43, October.
  12. Louis Kaplow, 2006. "Optimal Control of Externalities in the Presence of Income Taxation," NBER Working Papers 12339, National Bureau of Economic Research, Inc.
  13. Ebert, Udo, 1992. "A reexamination of the optimal nonlinear income tax," Journal of Public Economics, Elsevier, vol. 49(1), pages 47-73, October.
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