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Pigou Meets Mirrlees: On the Irrelevance of Tax Distortions for the Second-Best Pigouvian TaxBas JacobsTilburg 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 MooijInternational 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 Abstract: 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, H230 working papers seriesDate posted: February 14, 2011Suggested CitationContact Information
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