Taxing Externalities Without Hurting the Poor

52 Pages Posted: 9 Aug 2022 Last revised: 29 Feb 2024

See all articles by Mallesh Pai

Mallesh Pai

Rice University

Philipp Strack

Yale, Department of Economics

Date Written: July 27, 2022

Abstract

We consider the optimal taxation of a good which exhibits a negative externality, in a setting where agents differ in their value for the good, their disutility from the externality, and their value for money, while the planner observes neither. Pigouvian taxation is the unique Pareto efficient mechanism, yet it is only optimal if the planner puts higher Pareto weights on richer agents. We derive the optimal tax schedule for both a narrow allocative objective and a utilitarian objective for the planner. The optimal tax is generically nonlinear, and Pareto inefficient. The optimal mechanism might take a “non-market” form and cap consumption, or forbid it altogether. We illustrate the tractability of our model by deriving closed form solutions for the lognormal and Rayleigh distribution. Finally, we calibrate our model and derive optimal taxes for the case of air travel.

Keywords: externalities, redistribution, taxation, mechanism design

JEL Classification: D82, H21

Suggested Citation

Pai, Mallesh and Strack, Philipp, Taxing Externalities Without Hurting the Poor (July 27, 2022). Available at SSRN: https://ssrn.com/abstract=4180522 or http://dx.doi.org/10.2139/ssrn.4180522

Mallesh Pai

Rice University ( email )

6100 South Main Street
Houston, TX 77005-1892
United States

Philipp Strack (Contact Author)

Yale, Department of Economics ( email )

28 Hillhouse Ave
New Haven, CT 06520-8268
United States

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