POLLUTION TAXES AND REVENUE RECYCLING

Discussions of environmental policy and the tax system have emphasized the value of pollution tax revenues, which can be used to reduce other tax distortions in the economy. However by raising private marginal production costs, environmental taxes also tend to reduce GDP and exacerbate the welfare costs of conventional taxes. For environmental taxes in consumption goods industries, the net welfare change from these two effects is negative unless this good is a relatively weak substitute for leisure. An estimate for the optimal pollution tax with full revenue recycling is 63 to 78% of marginal environmental damages. (C) 1995 Academic Press, Inc.