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http://ssrn.com/abstract=623908
 
 

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Tax Deductions, Environmental Policy, and the Double Dividend Hypothesis


Ian W. H. Parry


Resources for the Future

Antonio M. Bento


University of California, Santa Barbara

May 1999

World Bank Policy Research Working Paper No. 2119

Abstract:     
Recent studies find that environmental tax swaps typically exacerbate the costs of the tax system and therefore do not produce a double dividend. This paper extends previous models by incorporating tax-favored consumption goods. In this setting, the efficiency gains from recycling environmental tax revenues are larger because preexisting taxes distort the consumption bundle, in addition to factor markets. A genuine double dividend is then found.

Parry and Bento find that incorporating tax-favored consumption in models of environmental tax swaps may overturn key results from earlier studies. In particular, a revenue-neutral pollution tax (or auctioned permits) can produce a substantial double dividend by reducing both pollution and the costs of the tax system. The second dividend arises because the welfare gain from using environmental tax revenues to cut labor taxes is much larger when labor taxes also distort the choice among consumption goods. Indeed (ignoring environmental benefits), the overall costs of a revenue - neutral pollution tax are negative in the benchmark simulations, at least for pollution reductions up to 17 percent, and possibly up to 42 percent.

In addition, Parry and Bento show that the presence of tax-favored consumption may drastically increase the efficiency gain from using (revenue-neutral) emissions taxes (or auctioned emissions permits) rather than grandfathered emissions permits.

This paper - a product of Infrastructure and Environment, Development Research Group - is part of a larger effort in the group to study regulatory policies in a second-best setting. The authors may be contacted at parry@rff.org or abento@worldbank.org.

Number of Pages in PDF File: 38

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Date posted: December 5, 2004  

Suggested Citation

Parry, Ian W. H. and Bento, Antonio M., Tax Deductions, Environmental Policy, and the Double Dividend Hypothesis (May 1999). World Bank Policy Research Working Paper No. 2119. Available at SSRN: http://ssrn.com/abstract=623908

Contact Information

Ian W. H. Parry
Resources for the Future ( email )
1616 P Street, NW
Washington, DC 20036
United States
202-328-5151 (Phone)
202-939-3460 (Fax)
HOME PAGE: http://www.rff.org/~parry
Antonio M. Bento (Contact Author)
University of California, Santa Barbara ( email )
Santa Barbara, CA 93106
United States
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