Environmental Taxation and the 'Double Dividend: A Reader's Guide'
Center for Economic Studies Working Paper at University of Munich, Number 74
Posted: 1 Sep 1999
Date Written: November 1994
Abstract
In recent years there has been great interest in the possibility of substituting environmentally motivated or "green" taxes for ordinary income taxes. Some have suggested that such revenue- neutral reforms might offer a "double dividend:" not only (1) improve the environment but also (2) reduce certain costs of the tax system. This paper articulates different notions of "double dividend" and examines the theoretical and empirical evidence for each. It also draws connections between the double dividend issue and principles of optimal environmental taxation in a second-best setting. A weak double dividend claim is that returning tax revenues through cuts in distortionary taxes leads to cost savings relative to the case where revenues are returned lump sum. This claim is easily defended on theoretical grounds and (thankfully) receives wide support from numerical simulations. The stronger versions contend that revenue-neutral swaps of environmental taxes for ordinary distortionary taxes involve zero or negative gross costs. Theoretical analyses and numerical results tend to cast doubt on the strong double dividend claim. At the same time, the theoretical case against the strong form is not air-tight, and the numerical evidence is mixed. In simple models, the conditions under which the strong double dividend claim is rejected (upheld) are closely related to the conditions under which the second-best optimal environmental tax is less than (greater than) the marginal environmental damages.
JEL Classification: D58, H21, H22
Suggested Citation: Suggested Citation