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Optimal Tax Policy, Market Imperfections, and Environmental Externalities in a Dynamic Optimizing Macro Model

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  • JUIN-JEN CHANG
  • JHY-HWA CHEN
  • JHY-YUAN SHIEH
  • CHING-CHONG LAI

Abstract

This paper develops a dynamic real business cycle model that highlights pollution externalities (on welfare and production) and market imperfections and uses it to determine the socially optimal tax policy that encompasses labor income, capital income, and emission taxes. We show that the optimal tax on capital and labor income only addresses the production inefficiency (and is time-invariant), while the tax on the environmental externalities affects both the production inefficiency and the environmental spillovers (and is time-varying). More interestingly, the socially optimal emission tax will be characterized by a Keynesian-like stabilizer that is designed to mitigate business cycle fluctuations, i.e., that will stimulate the economy with a lower emission tax during recessions. In a positive analysis, we show that the beneficial effects arising from pollution taxation will become larger the greater is the degree of the firms' monopoly power. In addition, a triple dividend in terms of improving environmental quality and increasing employment and firms' profit can be simultaneously realized if the environmental production externality is more significant and if the elasticity of intertemporal substitution in consumption is relatively small. Copyright © 2009 Wiley Periodicals, Inc..

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  • 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, August.
  • Handle: RePEc:bla:jpbect:v:11:y:2009:i:4:p:623-651
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    Cited by:

    1. Barbara Annicchiarico & Francesca Diluiso, 2017. "International Transmission of the Business Cycle and Environmental Policy," CEIS Research Paper 423, Tor Vergata University, CEIS, revised 19 Dec 2017.
    2. Hashmat Khan & Christopher R. Knittel & Konstantinos Metaxoglou & Maya M. Papineau, 2015. "Carbon Emissions and Business Cycles," Carleton Economic Papers 15-07, Carleton University, Department of Economics, revised 17 May 2018.
    3. Chu, Hsun & Lai, Ching-chong & Liao, Chih-hsing, 2016. "A Note On Environment-Dependent Time Preferences," Macroeconomic Dynamics, Cambridge University Press, vol. 20(06), pages 1652-1667, September.
    4. Dissou, Yazid & Karnizova, Lilia, 2016. "Emissions cap or emissions tax? A multi-sector business cycle analysis," Journal of Environmental Economics and Management, Elsevier, vol. 79(C), pages 169-188.
    5. Bowen, Alex & Stern, Nicholas, 2010. "Environmental policy and the economic downturn," LSE Research Online Documents on Economics 37589, London School of Economics and Political Science, LSE Library.
    6. Chu, Hsun & Lai, Ching-chong, 2014. "Abatement R&D, market imperfections, and environmental policy in an endogenous growth model," Journal of Economic Dynamics and Control, Elsevier, vol. 41(C), pages 20-37.
    7. Anna Grodecka & Karlygash Kuralbayeva, 2014. "The Price vs Quantity Debate: Climate policy and the role of business cycles," OxCarre Working Papers 137, Oxford Centre for the Analysis of Resource Rich Economies, University of Oxford.
    8. Tomomi Miyazaki, 2016. "Fiscal stimulus effectiveness in Japan: evidence from recent policies," Applied Economics, Taylor & Francis Journals, vol. 48(27), pages 2506-2515, June.

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