Second-Best Pollution Taxes

13 Pages Posted: 19 May 1998 Last revised: 4 Dec 2013

See all articles by Don Fullerton

Don Fullerton

University of Illinois at Urbana-Champaign - Department of Finance; National Bureau of Economic Research (NBER); CESifo (Center for Economic Studies and Ifo Institute)

Date Written: March 1996

Abstract

When government needs more revenue than is available from a pollution tax rate equal to marginal environmental damage, our intuition tells us to raise the tax on the clean good above zero and to raise the tax on the dirty good above that first-best Pigouvian rate. Yet new results suggest that the second-best pollution tax is below the Pigouvian rate. This note reconciles these views by pointing out that these new results use a labor tax to acquire additional revenue, and that the labor tax is equivalent to a uniform tax on both clean and dirty goods. Thus, depending on the normalization, the total tax on the dirty good can be above the Pigouvian rate. These recent results are meant to show that the difference between the tax on the dirty good and the tax on the clean good is less than the Pigouvian rate. Any one tax rate can be set to zero as a conceptual matter, but implementation of some taxes might be easier than others as a practical matter.

Suggested Citation

Fullerton, Don, Second-Best Pollution Taxes (March 1996). NBER Working Paper No. w5511. Available at SSRN: https://ssrn.com/abstract=4017

Don Fullerton (Contact Author)

University of Illinois at Urbana-Champaign - Department of Finance ( email )

1206 South Sixth Street
Champaign, IL 61820
United States
(217) 244-3621 (Phone)

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

CESifo (Center for Economic Studies and Ifo Institute)

Poschinger Str. 5
Munich, DE-81679
Germany

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