Pollution, Mortality and Optimal Environmental Policy

We study pollution, mortality and growth in an overlapping generations economy with uncertain lifetimes. Economic activity creates pollution: the stock of pollution has a negative effect on life expectancy while higher income (proxying either for better nutrition and immunity or for better availability of public health) has a prophylactic effect on mortality. These counteracting effects can make the growth-survival relationship non-concave and lead to multiple steady states and a poverty trap. An increase in exogenous abatement taxes can increase the basin of the poverty trap. We study a dynamically consistent sequence of secondbest abatement taxes. The optimal tax is shown to be a non-homogeneous and increasing function of the current capital stock with the optimal tax zero for low levels of capital. The feedback effect from the capital stock to the optimal tax can make optimal abatement policy an independent source of non-linearities leading to non-existence and multiplicity of steady states, as well as oscillations around some steady states when there are none under exogenous taxes.