Empirical Estimates for Environmental Policy Making in a Second-Best Setting

Abstract

This study estimates parameters necessary to calculate the optimal second-best gasoline tax, most notably the cross-price elasticity between gasoline and leisure. Prior work indicates that in a secondbest setting with distortionary income taxes, both the cost of environmental regulation and the optimal environmental tax rate depend crucially on the cross-price elasticity between a polluting good and leisure. However, no prior study on second-best environmental regulation has estimated this elasticity. Using household data, we find that gasoline is a relative complement to leisure, and thus that the optimal gasoline tax is significantly higher than marginal damages-the opposite of the result suggested by the prior literature. Following this approach to estimate cross-price elasticities with leisure for other major polluting goods could strongly influence estimates of optimal environmental taxes.

Estimates from a consumer demand system: implications for the incidence of environmental taxes

“…26 This is the optimal second-best gas tax found by West and Williams [34], based on demand system estimates similar to those in the present paper, but with a representative agent model. That study in turn used an estimate of 83 cents for the marginal external damage per gallon of gasoline, which was taken from a survey by Parry and Small [24].…”

“…This data set and estimation approach are very similar to those used by West and Williams [34], with the only major difference being that the present paper estimates the demand system separately for each quintile. However, the two papers differ greatly in how they use the demand system estimates.…”

“…However, the two papers differ greatly in how they use the demand system estimates. The present paper focuses on incidence, whereas West and Williams [34] focuses exclusively on the calculation of optimal gas tax rates and does no incidence analysis.…”

“…For a recent survey of this literature, see Goulder [13]. West and Williams [34] focuses specifically on the effect of the cross-price elasticity between gasoline and leisure on the efficiency of the gasoline tax. measures will illustrate the importance (or lack thereof) of incorporating behavioral changes in incidence estimates.…”

The distributional incidence of the gasoline tax in Chile

“…In general, the empirical evidence confirms the theoretical effects of the gasoline tax on the reduction of negative externalities (Haughton and Sarkar, 1996;Johansson and Schipper, 1997;Portney et al, 2003;West and Williams, 2004;Bento et al, 2005;Grabowski and Morrisey, 2006;Li et al, 2014;Spiller et al, 2014). Consistently, the evidence for European countries shows that the effects of gasoline taxes on global carbon emissions makes it a significant instrument of climate policy (Sterner, 2007).…”