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The author would like to thank Liam Ebrill for helpful comments.
Bovenberg and Goulder (1996) empirically determine the optimal carbon tax using a dynamic computable general equilibrium model for the U.S. economy. They find that optimal carbon taxes are far below the marginal environmental damages.
See Hanley and Spash (1993) for an overview of various methods to estimate the monetary benefits of nonmarketed goods.
This is the decline in utility associated with raising $1 of additional public revenues.
Public abatement expenditures can be defined to include all those public spending activities aimed at the prevention, reduction, and elimination of pollution and nuisances that can have a harmful effect on the environment. For example, the cleaning-up of contaminated soil, treatment of exhaust gases, and water purification treatment. This definition excludes activities in the area of natural resource protection, which is in line with the definition of “Pollution Abatement and Control Expenditures” as employed by the OECD (1993). In practice, public abatement outlays are very small—for OECD countries on average 0.6 percent of GDP in 1990—since polluters are required to pay for the environmental damages if they can be identified (the so-called Polluter-Pays Principle).
Aggregate labor supply, L, is derived from N-V, where N is the total amount of time available to all households which can without loss of generality be normalized to unity.
Public abatement is treated as current public expenditure and is of the end-of-pipe type since the production technology is assumed to be given. That is, pollution is abated by installing more scrubbers rather than using the factor inputs in a less polluting way.
Without loss of generality this tax could have been imposed on the employer.
This assumption will be relaxed in the next section.
The government can directly choose the level of spending on public consumption and public abatement. However, it can only indirectly influence the provision of the public good of the environment through the setting of the labor tax rate and the level of public abatement.
Alternatively, the Pigovian tax rate could be expressed in terms of the marginal utility of leisure. This would yield the following expression: τp/(1−τp)=γEβH/UV.
This tax is implicit since no separate pollution tax is distinguished in the model. It thus forms part of the labor tax.
Harberger (1964) and Browning (1976) derive formulas for the MCPF that feature the compensated wage elasticity of labor supply. They maintain a constant level of public spending by means of a lump-sum rebate of labor tax revenue to households. The lump-sum rebate offsets any income effects so that only the pure substitution effect remains.
We refer here to the notion of distortionary taxes in the sense that the quantity of labor supplied is negatively affected by a higher labor tax rate.
Bovenberg and van der Ploeg (1994) have made this claim in a general equilibrium model with a clean and a polluting consumption good. Fullerton (1997), however, has noted that Bovenberg and van der Ploeg’s result is not as general as is suggested since it depends on the choice to set the tax on the clean commodity equal to zero. More correctly, they have proven that it should be the difference between the tax on the polluting and the clean commodity that is less than the Pigovian tax rate. In a model with only one tax rate this problem does not occur.
Log linearizing the right-hand side of (13) yields
However, it should be noted that both goals of public policy may be compatible in a world in which the burden of environmental taxation can be shifted toward agents outside the labor market. Ligthart and van der Ploeg (1996) show in an optimal tax model, in which output is produced with labor, polluting natural resources (e.g., energy), and a fixed factor, that capital owners bear a large part of the environmental tax burden if substitution between labor and natural resources is easy and the fixed factor does not substitute easily with the other factors of production.
In the case of strict (or additive) separability (as is assumed in equation (1)), public goods do not affect the level of private welfare either. This was the case considered by Atkinson and Stern (1974).
In a world where the government employs lump-sum taxes to balance its budget (i.e., G=HTH, where TH is a lump-sum tax levied on the representative household) the consumer effectively pays TH to finance public goods. However, the household receives αG in the form of public goods. In the aggregate, the household sector thus receives a net virtual income transfer of -(l-α)G. If 0<α<1, consumers effectively have to pay more through direct lump-sum taxes than the value of the public goods they receive. However, if α equals unity, households receive a zero net virtual income transfer implying that they are indifferent between private and public goods from a welfare point of view.
Private consumption and public consumption are substitutes (complements) if the marginal utility of one declines (increases) when the quantity of the other is increased. In the present case we have U′>0 and U′′ <0 and ∂(∂U/∂C)/∂G=θU″ which is positive (negative) if θ>0 (<0).
Note that Heijdra and Ligthart (1997) do not consider environmental externalities. However, they mainly focus on another distortion caused by imperfect competition in the goods market.
Without environmental externalities and leisure weakly separable from a Cobb-Douglas subutility function of private and public consumption the optimal level of public goods provision exactly matches the one under the first-best Samuelson rule.
A cleaner environment may also induce people to become more productive causing an upward shift in the labor demand curve. In this section we only focus on the effect of changes in environmental quality on the supply of labor.
These studies do not control for the possible negative effect of the increase in time assigned to recreational fishing on the demand for other recreational activities.