Alleviating Unemployment: The Case for Green Tax Reforms

It has been argued recently that imposing taxes on pollution produces additional tax revenues which can then be used to replace labour taxes and thus reap a double dividend in the form of improving environmental quality and alleviating unemployment. This paper analyses the employment effects of revenue-neutral green tax reforms by focusing on the revenue recycling effect on employment. Our model contains three features which are important when looking at the employment effects of green tax reforms: first, there is unemployment in equilibrium, second, wages are determined endogenously and third, various institutional arrangements for taxing unemployment benefits, for the price-indexation of unemployment benefits, and for personal tax allowances are considered. The employment effects of a revenue-neutral green tax reform are sensitive to institutional arrangements concerning taxation and indexation of unemployment benefits and personal tax allowances. A revenue-neutral green tax reform will boost employment if unemployment benefits are untaxed and nominally fixed. Employment actually falls if unemployment benefits are taxed and price indexed. When employment changes, the functional distribution of income also changes. Total private income, after-tax profits, and after-tax labour income increase with employment while transfer income decreases. If the polluting good is normal, a positive employment effect reduces the environmental dividend obtained from a revenue-neutral green tax reform.