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IV. Analytical extensions and
policy issues
A. Carbon taxes and fiscal interactions : are Pigovian taxes poss ible?
B. Econo my-wide ‘driver s’ of agricult ural expan sion and intens ifi cation.
C. Ove rview: envi ronmental policies in a second-be st world
Sour ces:
Bov enberg and Gou lder 1996
* Coxhead 2000
Brande r and Taylor 1997
* OEE Chap ter 3, Chapter 4.
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Is there a ‘double dividend’ from
environmental taxation?
• A ‘green’ tax may do more than merely reduce
emissions; its revenues may also permit reductions
of more distorting taxes.
– First dividend: improved environmental quality.
– Second dividend: welfare gain from a more efficient tax
system.
• Insight: an uncorrected externality (pollution) is a
distortion; correcting it raises welfare. To this can
maybe add additional welfare gain from reduction
in the average level of distortion in the tax system.
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• Implications (if correct): apply taxes to
polluting industries and welfare will
improve: a "win-win" policy scenario
– also averts controversy over the value of env.
gains.
• In GE, however, we must ask about the
effects of the environmental tax on costs in
other industries.
– E.g. energy price effect of a carbon tax. Will it
reduce real wages, eroding the base of the
income tax?
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P1
SMC
B
A
PMC
P0
MB
Z1
Z0
Emissions
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The first fi gur e shows a standa rd "demand for poll ution" diagr am in which
unregu lated firm s produc e Z0 unit s of poll ution , wher e the private marginal
cost is just equa l to the marginal bene fit.
-- The external cost is reflected in an SMC curve high er than PMC,and the
sociall y op tim al poll ution rate is just Z1.
-- A Pigovian tax would achieve this by taxing the output of poll ution at a
rate q, such th at P1 = P0(1 + q).
-- This would raise revenue of area A and im prove welfare by triang le B
(the ex cess of SMC over MB at the o riginal poll ution level).
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Wg 0
C
D
Wn 0
Wn 1
L1
L0
Labor hours
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In the second figur e we have initi al employmen t L0;
Gross wage:
Wg
Net wage (after labor tax at rate t):
Wn = Wg(1 – t)
Real net wage (at consumer prices Pc): Wg(1 – t)/Pc.
Initial deadweight loss associated with t is area C
DD argument: Revenue from envi ronmental tax (A) can be
used to reduce the rate of the income tax (t), so reducing the
DWL, C. This is the ‘second’ divid end.
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In an economy with pre-existing distortions, there can be no
presumption of a “second” dividend.
If an environmental t ax permits a small reduction in t but raises
Pc by proportionally mo re, the real net wage could fall— e.g. to
Wn1 in the figur e.
Ex.: Real net wage effect is the same, whether tax raised
from t = 0 to t = 0.5, or consumer prices are increased
from Pc = 1 to Pc = 2.
If the real wage falls, then the DWL associated with th e income
tax will increase by area D. This is due to the negativ e labor
supply effect of a fall in th e real net wage.
In this case the second ‘divid end’ is negativ e and the net
welfare gain from an environm ental tax will depend on area B
being g reater than D. This is not assured.
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Wg0
P1
SMC
B
C
D
A
PMC
P0
Wn0
MB
Z1
Z0
Emissions
Wn1
L1
L0
Labo r hours
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Thus :
“...env ir onmental taxes typically exace rbate, rather than all eviate,
preexisting tax d is tortions— even if revenues a re employed to cut
preexisting distortiona ry taxe s...In the presence of preexisting
distortiona ry taxe s, the op tim al pollution tax typicall y lies below
the Pigouv ian tax” (Bovenberg and de Mooij, p.1085).
Differences between Pigouvian and second- best carbon tax ra tes
($/ton C emitted)
Assumed
Optim al tax,
Optim al tax,
marginal env .
Pigouv ian
lump-sum
persona l t ax
damage
tax
rebate
cut
















Source: Bovenberg & Goulder 1996.
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• Partial equilibrium DD analysis suggests that no
matter how uncertain the value of environmental
gains, a green tax would be a good thing to adopt
by virtue of the second (fiscal) dividend.
– Because it ignores indirect effects on the supply of
labor
• However, in debates over the welfare implications
of environmental taxes general equilibrium
analysis places the burden of proof back onto their
advocates.
– If the green tax reduces real wages, 2nd dividend < 0
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Applicability to LDCs
• A tax increase can only be passed on as higher
prices under some sets of conditions.
• Sectoral responses to an emissions tax may -->
factor market adjustments (including further wage
changes).
– In most LDCs, emissions taxes will hurt mfg much
more than agric., and could even cause real wages to
increase under some conditions.
• Other taxes (e.g. trade taxes) may be more
important in terms both for environment and
revenues…
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• S-S theorem: A rise in a price raises real returns to
the intensively used factor and reduces those to the
other factor. This is regardless of the source of the
price rise.
• A tax on the output of a polluting industry is
equivalent to a producer price reduction unless the
tax can be fully passed on.
• Thus if the polluting industry is K-intensive, a
green tax will raise w and reduce r in real terms.
• Thai data suggest environmental gains from trade
liberalization…
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Protection, factor intensity and emissions data for Thai manufacturing
industries (weighted average; s.d. in parentheses)
Importcompeting
Exporting
(n=45)
(n=29)
Effectiv e rate of protection (ERP)
139.39
-12.01
(12.359)
(1.126)
Nomin al rate of protection (NRP)
44.06
1.22
(2.685)
(0.168)
Labor-int ensity (labor cost as a
0.42
0.61
fraction of total cost)
(0.015)
(0.033)
AHTI score (lin ear ind ex)
6.47
2.92
(0.201)
(0.153)
Sources: Bank of Thailand and Hettig e et al..
a
Calculated using wit hin -group w eigh ts based on value of domestic produc tion.
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Conclusions
• The prospects for a ‘double dividend’ from tax
reform in LDCs appear reasonably good.
– The assumptions made in the literature are not
transparently the most appropriate to the “small country
case” that is typical of Asian LDCs, and the DD results
are shown to be sensitive to these assumptions.
– However, green taxes are minor in LDC tax systems.
• Conversely, the reform of tax systems in ways that
reduce overall distortions has the potential to
generate environmental benefits.
– Trade liberalization can be good for the environment-but only if other policies and conditions are also right.
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Discussion
• Role of environmental taxes in the fiscal systems
of LDCs
• Practical and institutional challenges to
incorporation of environmental policies in fiscal
systems
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