Pigou Meets Mirrlees: On the Irrelevance of Tax Distortions for the Second-Best Pigouvian Tax
Tilburg University, CentER; Netspar; University of Amsterdam - Amsterdam School of Economics (ASE); CESifo (Center for Economic Studies and Ifo Institute for Economic Research)
Ruud A. De Mooij
International Monetary Fund (IMF); CESifo (Center for Economic Studies and Ifo Institute for Economic Research); Oxford University Centre for Business Taxation
February 14, 2011
CESifo Working Paper Series No. 3342
This paper extends the Mirrlees (1971) model of optimal income redistribution with optimal corrective taxes to internalize consumption externalities. It is demonstrated that the optimal second-best tax on an externality-generating good should not be corrected for the marginal cost of public funds. The reason is that the marginal cost of public funds equals unity in the optimal tax system, since marginal distortions of taxation are equal to marginal distributional gains. The Pigouvian tax needs to be modified, however, if polluting commodities or environmental quality are more complementary to leisure than non-polluting commodities are.
Number of Pages in PDF File: 32
Keywords: marginal cost of public funds, optimal environmental taxation, optimal redistribution, externalities
JEL Classification: D620, H210, H230working papers series
Date posted: February 14, 2011
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