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Tax Deductible Spending, Environmental Policy, and the "Double Dividend" Hypothesis

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  • Parry, Ian W.H.
  • Bento, Antonio M.

Abstract

A number of recent studies have shown that the general equilibrium welfare effects of externality-correcting policies depend importantly on pre-existing taxes in the economy, particularly those that distort the labor market. This paper extends the prior literature by allowing for consumption goods that are deductible from labor taxes. These "goods" represent medical insurance, other less tangible fringe benefits, mortgage interest, and so on. The initial tax system effectively subsidizes tax-favored consumption relative to other consumption, in addition to distorting the labor market. We find that incorporating tax-favored consumption may overturn key results from earlier studies. In particular, a revenue-neutral pollution tax (or auctioned pollution permits) can produce a substantial "double dividend" by reducing both pollution and the costs of the tax system. The second dividend arises because the welfare gain from using environmental tax revenues to cut labor taxes is much larger when labor taxes also distort the choice among consumption goods. Indeed (ignoring environmental benefits) the overall costs of a revenue-neutral pollution tax are negative in our benchmark simulations, at least for pollution reductions up to 17 percent, and possibly up to 42 percent. In addition, we show that the presence of tax-favored consumption may dramatically increase the efficiency gain from using (revenue-neutral) emissions taxes (or auctioned emissions permits) over grandfathered emissions permits.

Suggested Citation

  • Parry, Ian W.H. & Bento, Antonio M., 1999. "Tax Deductible Spending, Environmental Policy, and the "Double Dividend" Hypothesis," Discussion Papers 10737, Resources for the Future.
    • Handle: RePEc:ags:rffdps:10737
    DOI: 10.22004/ag.econ.10737
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    Cited by:

    1. Haqiqi, Iman & Manzoor, Davood, 2012. "Environmental Impacts of Phasing out Energy Subsidies," MPRA Paper 95688, University Library of Munich, Germany, revised 2016.
    2. Yunfa Zhu & Madanmohan Ghosh & Deming Luo & Nick Macaluso & Jacob Rattray, 2018. "Revenue Recycling And Cost Effective Ghg Abatement: An Exploratory Analysis Using A Global Multi-Sector Multi-Region Cge Model," Climate Change Economics (CCE), World Scientific Publishing Co. Pte. Ltd., vol. 9(01), pages 1-25, February.
    3. Goulder, Lawrence H., 2002. "Mitigating the Adverse Impacts of CO2 Abatement Policies on Energy-Intensive Industries," Discussion Papers 10642, Resources for the Future.
    4. Ian W. H. Parry & Antonio Bento, 2001. "Revenue Recycling and the Welfare Effects of Road Pricing," Scandinavian Journal of Economics, Wiley Blackwell, vol. 103(4), pages 645-671, December.
    5. Parry, Ian, 1999. "Tax Deducations, Consumption Distortions, and the Marginal Excess Burden of Taxation," RFF Working Paper Series dp-99-48, Resources for the Future.
    6. Jean-Christophe Caffet, 2005. "Health effects and optimal environmental taxes in welfare state countries," Post-Print halshs-00194917, HAL.
    7. Font Vivanco, David & Nechifor, Victor & Freire-González, Jaume & Calzadilla, Alvaro, 2021. "Economy-wide rebound makes UK’s electric car subsidy fall short of expectations," Applied Energy, Elsevier, vol. 297(C).
    8. Amani Abdallah Assolie & Rana Imam & Ibrahim Khliefat & Ala Alobeidyeen, 2024. "Modeling of Applying Road Pricing to Airport Highway Using VISUM Software in Jordan," Sustainability, MDPI, vol. 16(18), pages 1-49, September.
    9. Jean-Christophe Caffet, 2005. "Health effects and optimal environmental taxes in welfare state countries," Cahiers de la Maison des Sciences Economiques v05049, Université Panthéon-Sorbonne (Paris 1).

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