Optimal Environmental Taxation in the Presence of Other Taxes: General Equilibrium Analyses
Most economies feature levels of public spending that require more tax revenues than would be generated solely from the pollution taxes set according to the Pigovian principle, that is, set equal to marginal environmental damages. As a consequence, tax systems generally rely on both environmental (corrective) and other taxes. However, economists typically have analyzed environmental taxes without taking into account the presence of other, distortionary taxes. The omission is significant because
... significant because the consequences of environmental taxes depend fundamentally on the levels of other taxes, including income and commodity taxes. This paper examines how optimal environmental tax rates deviate from rates implied by the Pigovian principle in a second-best setting where other, distortionary taxes are present. Previous investigations of this issue include the partial equilibrium analyses of Dwight R. Lee and Walter S. Misiolek ( 1986) and Wallace E. Oates ( 1991), who derive formulas linking the optimal rate for a newly imposed environmental tax to the marginal excess burden from existing taxes. In a general-equilibrium setting, Agnar Sandmo (1975) and Bovenberg and Frederick van der Ploeg (1994) have demonstrated how the well-known "Ramsey" formula for optimal commodity taxes is altered when one of the consumption commodities generates an externality.