A Growth Theoretical Approach
Chapter 5: Green Accounting and Distortionary Taxation
The decentralized economy analyzed so far contains a single distortion: an external effect associated with environmental damage. Within such a framework, one of the main purposes of Chapter 2 was to derive exact welfare measures in an uncontrolled or imperfectly controlled market economy and compare them with the ﬁrst best welfare measure. However, although market failures have important implications for welfare measurement, our previous analysis was based on the assumption that the ﬁrst best can (in principle) be attained by means of a properly designed policy rule. This basic idea was further explored in Chapter 4, where we argued that such policy rules are difﬁcult to implement in practice, which may necessitate a ‘practical approach’ to social accounting. On the other hand, if we were to relax the assumption that the government has the appropriate policy instruments for implementation of the ﬁrst best, the concept of social optimum would also change. One example – thoroughly addressed in other areas of welfare economics – is that the public revenues have to be raised by distortionary taxes. This is clearly relevant for welfare measurement, since distortionary taxation gives rise to a welfare cost. In Section 5.1, we consider green accounting under distortionary taxes and explain why the green NNP in utility terms derived earlier may fail to measure welfare in this case, as well as derive a second best analogue to the green NNP in utility terms. Although the step from the ﬁrst best to the second best resource allocation has practical value...
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