Edited by Jeroen C.J.M. van den Bergh
Chapter 20: The Double Dividend of an Environmental Tax Reform
Ruud A. de Mooij' 1. Introduction Recently, environmental tax reforms have received increasing attention from economists. The question is whether a shift from ordinary taxes on income towards pollution taxes can improve the quality of the environment and, at the same time, enhance the efficiency of taxation as a revenueraising device. This is called the double-dividend hypothesis. This chapter sheds some light on this debate by discussing the theoretical and empirical literature on the double-dividend hypothesis. Furthermore, it elaborates on some political-economy aspects that have as yet received little attention in this literature. 2. Theory of second-best environmental taxation In his seminal book, Pigou has shown that pollution taxes are able to internalize the adverse externalities associated with polluting activities (Pigou, 1947). Indeed, in a first-best world without other distortions it is optimal to set the pollution tax equal to the marginal environmental damage from pollution. The revenue of this so-called Pigouvian tax is assumed to be returned to economic agents in a lump sum fashion. In a second-best world with pre-existing tax distortions things are different. In particular, public finance theory tells us that replacing distortionary taxes on labour or capital by lump sum taxes yields an improvement in the efficiency of the tax system as a revenue-raisingdevice. This is because lump sum taxes do not drive a wedge between producer and consumer prices and thus leave the allocation of goods unchanged. Some authors have used this result to argue that raising pollution taxes and using the revenues to...
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