Environmental tax policy, habit formation and nonlinear dynamics

In this paper, we study the impact of environmental tax policy on the dynamic property in an environment-growth model (John and Pecchenino 1994)[3]. We assume that the government levies consumption tax and uses the tax revenue to improve environmental quality. We show that the economic dynamics can be represented by a first-order difference equation in environmental quality when there is no habit formation of environmental quality. If agents have habit formation of environmental quality, the economic dynamics will be represented by a second-order difference equation in environmental quality. In both cases, chaotic and cyclical fluctuations may exist if agents' preference towards environmental quality, the maintenance efficiency relative to degradation and the tax rate are sufficiently low. However, the economy undergoes transformation from complex dynamics to simple dynamics as the tax rate increases. Furthermore, in the presence of habit formation of environmental quality, an increase in the degree of habit formation lowers the possibility of complex dynamics. (C) 2010 Elsevier Ltd. All rights reserved.