Double Dividend with Trade Distortions: Analytical Results and Evidence from Chile

The double-dividend debate evolves around the possibility (or not) of substituting environmental taxes for more distortionary taxes to reduce both pollution degradation and/or damages (the first dividend) and the excess burden of existing taxes (the second dividend), without eroding tax revenues. This paper contributes to the double dividend debate with a formal analysis and some numerical evidence emphasizing trade and environmental distortions. The substitution of environmental taxes for trade distortions has been neglected in the double-dividend debate, which has centered on labor market distortions. Conditions for the existence of a double dividend are derived for different characterizations of preferences and policy menus. We empirically explore the trade/environment double dividend with an applied general equilibrium model of the Chilean economy. The model includes many distortions and a vector of six air pollution effluents, their health incidences and associated damages, which are assumed nonseparable from market goods. Findings suggest solid evidence of a trade/environment double dividend in the case of Chile. Swapping environmental taxes for trade distortions improves welfare. The swap would even pay for itself under the assumption of separable pollution damages from market-good consumption.