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Second‐Best Pollution Taxes and the Structure of Preferences

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  • Helmuth Cremer
  • Firouz Gahvari
  • Norbert Ladoux

Abstract

We characterize optimal taxes on polluting and nonpolluting goods in Ramsey and Mirrlees second‐best environments. The polluting good tax differs from the Pigouvian tax by Ramsey terms in the first and by Stiglitz/Mirrlees plus another adjustment term in the second. These terms can be positive, negative, or zero. If preferences are weakly separable in public and private goods, with the private good subutility weakly separable in labor and produced goods, nonpolluting goods are taxed uniformly and the concept of a tax differential between polluting and nonpolluting goods is well defined. The differential is then less than the Pigouvian tax in the Ramsey framework, but it can be greater, equal to, or smaller than the Pigouvian tax in the Mirrlees second best. In Mirrlees second best, if preferences are separable in labor supply and other goods, the second‐best tax differential is identical to the Pigouvian tax.

Suggested Citation

  • Helmuth Cremer & Firouz Gahvari & Norbert Ladoux, 2001. "Second‐Best Pollution Taxes and the Structure of Preferences," Southern Economic Journal, John Wiley & Sons, vol. 68(2), pages 258-280, October.
    • Handle: RePEc:wly:soecon:v:68:y:2001:i:2:p:258-280
    DOI: 10.1002/j.2325-8012.2001.tb00419.x
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