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From Pigou to Extended Liability: On the Optimal Taxation of Externalities Under Imperfect Financial Markets

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  • Jean Tirole

Abstract

Pigovian taxation of externalities has limited appeal if the tortfeaser has insufficient resources to pay the damage when it occurs. To defend Pigovian taxation in the presence of judgement-proof agents, its proponents point at the many institutions extending liability to third parties. Yet little is known about the validity of Pigou's analysis in this context. The paper analyses the costs and benefits of extended liability and investigates whether full internalization is called for in the presence of agency costs between potential tortfeasers and providers of guarantees. Its contribution is two-fold. It first shows that the better the firms' corporate governance and the stronger their balance sheet, the more closely taxes should track the corresponding externality. It then develops the first analysis of extended liability when guarantors themselves may be judgement-proof, and the extension of liability may give rise to further externalities. Relatedly, it derives the curvature of the optimal taxation of externalities in a multi-plant firm. Copyright , Wiley-Blackwell.

Suggested Citation

  • Jean Tirole, 2010. "From Pigou to Extended Liability: On the Optimal Taxation of Externalities Under Imperfect Financial Markets," Review of Economic Studies, Oxford University Press, vol. 77(2), pages 697-729.
  • Handle: RePEc:oup:restud:v:77:y:2010:i:2:p:697-729
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    File URL: http://hdl.handle.net/10.1111/j.1467-937X.2009.00585.x
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    Cited by:

    1. Ben White & Graeme J. Doole & David J. Pannell & Veronique Florec, 2012. "Optimal environmental policy design for mine rehabilitation and pollution with a risk of non‐compliance owing to firm insolvency," Australian Journal of Agricultural and Resource Economics, Australian Agricultural and Resource Economics Society, vol. 56(2), pages 280-301, April.
    2. Michau, Jean-Baptiste, 2015. "Optimal labor market policy with search frictions and risk-averse workers," Labour Economics, Elsevier, vol. 35(C), pages 93-107.
    3. Hoffmann, Florian & Inderst, Roman & Moslener, Ulf, 2013. "Taxing Externalities under Financing Constraints," MPRA Paper 53855, University Library of Munich, Germany.
    4. Ben White, 2015. "Do control rights determine the optimal extension of liability to investors? The case of environmental policy for mines," Journal of Regulatory Economics, Springer, vol. 48(1), pages 26-52, August.

    More about this item

    JEL classification:

    • D62 - Microeconomics - - Welfare Economics - - - Externalities
    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
    • H23 - Public Economics - - Taxation, Subsidies, and Revenue - - - Externalities; Redistributive Effects; Environmental Taxes and Subsidies
    • J65 - Labor and Demographic Economics - - Mobility, Unemployment, Vacancies, and Immigrant Workers - - - Unemployment Insurance; Severance Pay; Plant Closings

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