Optimal Taxation, Redistribution, and Environmental Externalities

Abstract

This paper surveys research on optimal redistributive taxation in economies with environmental externalities. A major question is whether externality correction only motivates an adjustment of the tax policy rule for the externality-generating activity, or whether the marginal value of the externality directly enters the policy rules for other tax instruments as well. In a static benchmark model with an atmospheric consumption externality, where the government uses a mix of a nonlinear income tax and linear commodity taxes, we show that Sandmo's (1975) additivity property applies. This means that externality correction leads to an additional term (measuring the marginal value of the externality) in the commodity tax formula for the externality generating good, while the policy rules for commodity taxation of clean goods and marginal income taxation take the same form as in the absence of any externality. We also extend this benchmark model to capture a number of scenarios (such as non-atmospheric externalities, border trade in the externality generating good, and competition between governments in a multi-country framework), where the additivity property no longer applies. We end by examining an intertemporal model of optimal taxation with a stock-externality, allowing us to integrate the study of optimal redistributive taxation with literature on environmental economics and policy based on dynamic models.

Pigou in the 21st Century: a tribute on the occasion of the 100th anniversary of the publication of The Economics of Welfare

“…This setting generates an endogenous (optimality) argument to rely on distortionary income taxes for financing the government budget. Under specific conditions, equity and efficiency can be separated (Aronsson and Sjögren 2018 , provide an excellent overview). While the optimal environmental tax typically includes a component reflecting the marginal environmental damages, it may also contain further terms accounting for heterogeneity of households and overall costs of public funds.…”

“…There is already some research on the public economics of climate change that examines the fiscal properties of carbon pricing (de Mooij et al 2012 ; Edenhofer et al 2017 ; Jones et al 2013 ; Siegmeier et al 2018 ). Pigouvian taxation has also been studied in optimal taxation frameworks (for an excellent overview, see Aronsson and Sjögren 2018 ), where most attention has been given to the double dividend hypothesis (Goulder et al 2016 ) and distributional effects with respect to different incomes (e.g., Jacobs and van der Ploeg 2019 ).…”

“…Examples are different forms of heterogeneity combined with imperfect information, leakage effects due to jurisdictional spillovers, market concentration, innovation market failures, etc. In these settings, the fundamental research question is often whether the optimal environmental tax deviates from the ‘Pigouvian level’—and in what direction (Aronsson and Sjögren 2018 ; Cremer et al 2003 ; Jacobs and De Mooij 2015 ; Jacobs and van der Ploeg 2019 ; Parry 1995 ; Requate 2005a , 2005b ; Van der Ploeg 2016 ).…”

Optimal Carbon Taxation and Horizontal Equity: A Welfare-Theoretic Approach with Application to German Household Data

“…They rather pretend to be of low-productivity type to avoid higher tax payments. To address this problem, the government could consider so-called incentive compatibility constraints in their tax optimization problem (Mirrlees 1971, Aronsson andSjögren 2018), which require that no household can gain from pretending to be another household type. A key insight from the optimal taxation literature is further that optimized non-linear tax schedules that depend only on observable economic decisions (like the amount of energy consumed or the income generated) are also incentive compatible (Hammond 1979, Bierbrauer 2016).…”

Optimal Taxation, Environment Quality, Socially Responsible Firms and Investors

“…See also Cremer et al (2001) and the survey by Bovenberg and Goulder (2002). More recent works on this subject are Bontems and Bourgeon (2005), Goulder and Parry (2008), Gahvari (2014), Jacobs and De Mooij (2015), Kampas and Horan (2016), Belfiori (2018), Aronsson and Sjögren, (2018).…”