The objective of this research is investigate and confirm heretofore neglected theoretical results pertaining to the interactions between environmental taxes and revenue-raising taxes (i.e., the "double dividend" debate), and to assess their quantitative implications for environmental policies including ?green taxes' and other policy tools. The recent "tax interaction" literature has called into question long-held beliefs in economics about optimal environmental taxation, which has led to the conclusion that in the presence of revenue-raising taxes the optimal environmental tax lies below marginal social damages, that the optimal environmental tax varies inversely with government revenue requirements, and that non-revenue generating policies may reduce welfare for any level of abatement. The proposed research aims to demonstrate that these results stem from a set of unique definitions and assumptions that have produced misleading interpretations.
The proposed research project will:
1. derive general theoretical results for the optimal environmental tax in the presence of revenue-motivated taxes, and expressing it in relation to the value of marginal social damages as defined from society's perspective (a) for production as well as amenity externalities, (b) when the market mechanism does not generate revenues, and (c) when the source of income is not assumed to be limited to labor; and
2. construct numerical general-equilibrium models and estimate the magnitude of effects identified in the theoretical work. The models will be constructed and calibrated to provide estimates for the US economy relevant to externality problems such as climate change, acid rain, smog.
Expected Results: It is anticipated that the research will demonstrate several specific results with direct and important benefits for policymaking. By using general and neutral assumptions and standard definitions, the research will show that the optimal environmental tax generally exceeds marginal social damage (when defined in terms of social valuations, based on the marginal rate of substitution between income and environmental quality), that an increase in revenue requirements raises the optimal environmental tax, that in the case of production externalities environmental taxes increase employment, and that market mechanisms that do not generate revenues will only be welfare reducing if specific restrictions on preferences are imposed. The magnitude (and sign) of any "tax interaction effects" will be estimated. These results will contribute directly to meeting the Nation's needs cost-effectively by clarifying a debate which has generated considerable confusion among economists and policymakers alike.