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The Welfare Effects of Environmental Taxation

  • William Jaeger

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    Recent literature has investigated whether the welfare gains from environmental taxation are larger or smaller in a second-best setting than in a first-best setting. This question has mainly been addressed indirectly, by asking whether the second-best optimal environmental tax is higher or lower than the first-best Pigouvian rate. Even this indirect question has itself been approached indirectly, comparing the second-best optimal environmental tax to a proxy for its first-best value, marginal social damage (MSD). On closer examination, however, MSD becomes ambiguously defined and variable in a second-best setting making it an unreliable proxy for the Pigouvian rate. Given these observations, the current analysis reevaluates these welfare questions and finds that when compared directly to its first-best value, the second-best optimal environmental tax generally rises with increased revenue requirements. Even in cases where the second-best environmental tax is lower than its first-best value, the welfare gains may be greater than in a first-best setting. These results suggest that the marginal fiscal benefit (revenue recycling effect) exceeds the marginal fiscal cost (tax base effect) over a range of environmental tax rates that, for benchmark models, extends above the first-best Pigouvian rate. These findings reinforce the intuition that environmental policy complements rather than competes with the provision of other public goods. Copyright Springer Science+Business Media B.V. 2011

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    Article provided by European Association of Environmental and Resource Economists in its journal Environmental and Resource Economics.

    Volume (Year): 49 (2011)
    Issue (Month): 1 (May)
    Pages: 101-119

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    Handle: RePEc:kap:enreec:v:49:y:2011:i:1:p:101-119
    Contact details of provider: Web page: http://www.springerlink.com/link.asp?id=100263

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