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Optimal Environmental Regulation in the Presence of Other Taxes: The Role of Non-separable Preferences and Technology

  • Kim Seung-Rae


    (University of Texas at Austin)

Recent studies find that environmental taxes typically exacerbate pre-existing tax distortions and, therefore, the optimal pollution tax should lie below the Pigouvian level (social marginal damages). This paper analyzes a general equilibrium model with non-separable preferences and technology, relatively rare assumptions in this literature, and finds that the second-best optimal pollution tax can be above or below the first-best Pigouvian level. Surprisingly, the ordering of the two does not depend on the degree of pre-existing tax distortion. Moreover, it depends not just on the difference between the two goods' cross-price elasticities with leisure, but on that difference compared to the elasticity of demand for the polluting intermediate input. Finally, the paper shows that under plausible parameter conditions, a greater pre-existing tax distortion can increase the optimal level of environmental regulation.

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Article provided by De Gruyter in its journal The B.E. Journal of Economic Analysis & Policy.

Volume (Year): 1 (2002)
Issue (Month): 1 (July)
Pages: 1-27

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Handle: RePEc:bpj:bejeap:v:contributions.1:y:2002:i:1:n:4
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