Direct vs Indirect Taxation of Externalities : A General Treatment
It is well known that it may be possible to attain a Pareto-efficient allocation in an economy with consumption externalities by the imposition of suitable excise taxes and subsidies, although the imposition of such taxes may not be sufficient. In addition, the structure of these Pigovian excise taxes is familiar ; they are levied only on the externally-causing goods, and in general will differ across individuals. In practice, however, it is usually prohibitively costly to attempt to distinguish perfectly between individual externality creators, whereas it is often feasible to impose ordinary commodity taxes on externality-creating goods as a 'second-best' corrective measure. An example that is often cited is the case of pollution from the internal combustion engine ; it is infeasible to monitor the pollution emission of each separate car owner and tax him accordingly, but it is quite possible to tax petrol at a rate which is uniform across consumers. This fact has an important economic implication, which is that if corrective excise taxes are constrained to be uniform across individuals, 'first-best' allocations are usually not attainable, and therefore the choice of optimal tax structure is then a 'second-best' problem, even if lump-sum redistribution is possible.
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