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Second‐Best Pollution Taxes: an Analytical Framework and Some New Results[Note 1. The authors would like to thank two anonymous referees ...]
Author(s) -
Fuest Clemens,
Huber Bernd
Publication year - 1999
Publication title -
bulletin of economic research
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 0.227
H-Index - 29
eISSN - 1467-8586
pISSN - 0307-3378
DOI - 10.1111/1467-8586.00070
Subject(s) - economics , consumption (sociology) , tax deferral , commodity , consumption tax , microeconomics , environmental tax , indirect tax , tax basis , tax reform , public economics , gross income , state income tax , market economy , social science , sociology
This paper compares the second‐best optimal tax on polluting consumption goods with the Pigovian tax, which would internalize marginal environmental damage at a second‐best optimum. It is shown that the relationship between the optimal tax on polluting consumption and the Pigovian tax is determined by the substitutability between labour and polluting consumption or clean and polluting consumption, depending on whether a wage tax system or a commodity tax system is being considered. The key factor determining the relationship between the two taxes is gross substitutability between the two taxed goods. As long as there is gross substitutability, the optimal dirt tax exceeds the Pigovian tax. The opposite can occur if and only if the two goods are gross complements.