Pigouvian Income Taxation

Abstract

This paper develops a mechanism design approach to study externalities and re-distribution. The mechanism screens individuals’ social weights to strike a balance among broad distributional objectives, incentives to work, and incentives to reduce externalities. The welfare-optimal allocation can be decentralized through income taxation, defining income-dependent externality payments. Two applications use individual-level administrative data on incomes, pollution measures, and financial burdens to demonstrate how population characteristics shape the optimal policy on carbon emissions.

Keywords: Pigouvian taxation, optimal income taxation, inequality, climate change

JEL Classification: D820, H210, H230, Q540, Q580