DP745 Environmental Policy, Public Finance and the Labour Market in a Second-best World

Author(s): A Lans Bovenberg, Frederick van der Ploeg
Publication Date: December 1992
Keyword(s): Dirt Tax, Dirty Goods, Double Dividend, Environmental Externalities, Excess Burden, Labour Tax, Optimal Taxation, Public Goods
JEL(s): E60, H21, H41, Q28
Programme Areas: International Macroeconomics, Applied Macroeconomics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=745

Environmental and tax policies and the optimal provision of clean and dirty public goods are analysed within the context of a second-best framework of optimal taxation. Households consume both clean and dirty commodities. Degradation of the natural environment occurs due to the consumption of dirty private and public goods, but can be offset when the government engages in abatement activities. The `double dividend' hypothesis, i.e. raise the dirt tax and reduce the labour tax in order to enhance both environmental quality and employment, fails. Increased environmental concern implies a higher dirt tax, a lower tax on labour, less employment and economic activity and a cleaner environment. If the elasticity of substitution between private consumption commodities and leisure is large, and that between clean and dirty goods is small, public consumption expands while private consumption contracts. Otherwise, public consumption falls.