Information design,externalities, and government interventions

We consider a model of Bayesian persuasion with spillovers. A sender provides information to persuade a receiver to take an action with external effects. We consider how government interventions, including corrective subsidy and tax, affect social welfare. In addition to internalizing externalities, government interventions affect social welfare through an informational channel. Subsidies to the sender's preferred action incentivize the sender to reveal less information, but taxes on the sender's preferred action incentivize the sender to reveal more information. Because of such an informational effect, the optimal subsidy and tax may be different from the size of the externalities. In some cases, social welfare is maximized with no government intervention.     

Externality‐Correcting Taxes and Regulation*

In much of the literature on externalities, taxes and direct regulation have been considered as alternative policy instruments. Both instruments might be imperfect in practice, reflecting informational deficiencies and other limitations. We analyse the use of taxes and regulation in combination, to control externalities arising from individual consumption behaviour. We consider the cases either where taxes are imperfectly differentiated to reflect individual differences in externalities, or where some consumption escapes taxation. In both cases, we characterize the optimal instrument mix, and we show how changing the level of direct regulation alters the optimal externality tax.     

Direct versus indirect pigovian taxation

This paper considers the theory of optimal taxation in the presence of externalities when it is the uses of commodities in particular consumption processes which generate externalities, rather than the consumption of certain commodities as such. If the government is constrained to using ordinary commodity taxes (for reasons of imperfect information, costly control, etc.), it is demonstrated that there is a case for having taxes or subsidies on related goods in addition to a tax on the externality-creating commodity itself. The analysis also identifies the conditions under which related goods should be subsidized or taxed.     

Quantitative Import Restrictions and Optimal Capital Taxes Under a System of Tax Credits

This paper examines the optimal capital tax policy under quantitative import constraints, and international capital tax credits. For a small capital-importing country, the optimal capital tax equals the foreign tax under a quota, and equals or exceeds the foreign tax under a VER. For a small capital-exporting country, the optimal policy towards capital is a zero tax under a quota, and a tax or a subsidy under a VER. Also examined are the welfare effects of capital taxes and trade liberalization, and the joint setting of the two policies, when both instruments are available to the government.     

Optimal Design of Forest Taxation with Multiple-Use Characteristics of Forest Stands

The paper studies optimal forest taxation under uncertainty about future timber price when private forest owners value amenity services of forest stands and forest stands have public goods characteristics. It is assumed that preferences of forest owners can be described by a quasi-linear, intertemporal utility function which reflects risk aversion in terms of consumption and constant marginal utility in terms of amenity services. The comparative statics of current and future harvesting in terms of timber price risk, site productivity tax and yield tax are first developed. It is shown that, given the optimal site productivity tax, which is independent of the timber harvested and thus non-distortionary, it is desirable to introduce the yield tax at the margin; it both corrects externality due to the public goods characteristic of forest stands and serves as a social insurance device. The optimal yield tax is less than 100% and depends on the social value of forest stands, timber price risk and properties of compensated timber supply. In the general case the 'inverse elasticity rule – according to which the optimal yield tax is negatively related to the size of the substitution effects – may not hold. Under certainty, the desirability of the yield tax, given the optimal site productivity tax, depends only on the existence of public goods characteristic and is thus a pure Pigouvian tax.     

Externalities and optimal taxation

This paper reexamines the optimal tax design problem (income and commodities) in the presence of externalities. The nature of the second–best, and the choice of the tax instruments, are motivated by the informational structure in the economy. The main results are: (i) environmental levies (linear or nonlinear) differ in formula from Pigouvian taxes by the expressions for the optimal tax on private goods; (ii) externalities do not affect commodity tax formulas (linear and nonlinear) for private goods; (iii) externalities do not affect the income tax structure if commodity taxes are nonlinear and affect it if commodity taxes are linear; and (iv) a general income tax plus strictly Pigouvian taxes are sufficient for efficient taxation if individuals of different types have identical marginal rates of substitution (at any given consumption bundle).     

The optimal treatment of tax expenditures

This paper analyzes the optimal treatment of tax expenditures. It develops an optimal tax model where individuals derive utility from spending on a “contribution” good such as charitable giving. The contribution good has also a public good effect on all individuals in the economy. The government imposes linear taxes on earnings and on the contribution good so as to maximize welfare. The government may also finance directly the contribution good out of tax revenue. Optimal tax and subsidy rates on earnings and the contribution good are expressed in terms of empirically estimable parameters and the redistributive tastes of the government. The optimal subsidy on the contribution good is increasing in the size of the price elasticity of contributions, the size of the crowding out effect of public contributions on private contributions, and the size of the public good effect of the contribution good. Numerical simulations show that the optimal subsidy on contributions is fairly sensitive to the size of these parameters but that, in most cases, it should be lower than the earnings tax rate.     

Externalities,entry bias,and optimal subsidy policy for cleaner environment

This paper analyses alternative subsidy schemes and long-run entry bias in a new industry that creates positive environmental externalities (both generation externalities and externalities associated with interindustry technology spillovers). It demonstrates that per-unit subsidy scheme, despite attracting fewer firms, results in higher industry output and economic surplus in the equilibrium compared with the expenditure equivalent lump-sum subsidy scheme. However, the later leads to higher total surplus, unless spillover externalities are sufficiently small. Further, the free-entry equilibrium number of firms may be excessive or insufficient. A key finding of this paper is that the first-best equilibrium outcome can be implemented through a unique combination of per-unit subsidy and lump-sum subsidy/tax, which involves positive government expenditure in the presence of positive externalities.     

Trade,environment, and income inequality: An optimal taxation approach

In a small open economy, how should a government pursuing both environmental and redistributive objectives design domestic taxes when redistribution is costly? And how does trade liberalization affect the economy's levels of pollution and inequalities, when taxes are optimally and endogenously adjusted? Using a general equilibrium model under asymmetric information with two goods, two factors (skilled and unskilled labor), and pollution, this paper characterizes the optimal mixed tax system (nonlinear income tax and linear commodity and production taxes/subsidies) with both production and consumption externalities. While optimal income taxes are not directly affected by environmental externalities, conditions are derived under which under‐ or over‐internalization of social marginal damage is optimal for redistributive considerations. Assuming that redistribution operates in favor of the unskilled workers and that the dirty sector is intensive in unskilled labor, simulations suggest that trade liberalization involves a clear trade‐off between the reduction of inequalities and the control of pollution when the source of externality is only production; this is not necessarily true with a consumption externality. Finally, an increase in the willingness to redistribute income toward the unskilled results paradoxically in less pollution and more income inequalities.     

Attracting private investment: Tax reduction,investment subsidy,or both?

This paper uses a real-option model to examine the net benefit to a government from using tax cut and/or investment subsidy as incentives to induce immediate investment. Although earlier papers generally concluded that investment subsidy dominates tax cut, it is observed that many governments use a combination of subsidy and tax cut. We show that, when the government uses a different discount rate from private firms, and when it has to borrow money to provide an investment subsidy, it is possible to get an internal optimum; that is, it might be optimal for the government to provide an investment subsidy as well as charge a positive tax rate on the profits from the project. Thus, we provide an explanation for the puzzling fact that many governments provide an investment subsidy to a firm while simultaneously taxing its profits.     

The Role of Central Government in Tax Competition Between Heterogenous Regions

This paper analyzes the role of central government in a Nash tax competition between two heterogenous regions, which differ in their endowments of two production factors. Regional governments use a source-based unit tax on mobile capital to finance their public service expenditures. The central government employs excise subsidies and lump-sum taxes to induce the two regions to efficient resource allocations. We answer to the question that whether the central government can induce an efficient equilibrium, and investigate the effects of endowments difference on the optimum subsidy rates. We find that there exists a unique tax rate under which the efficiency is achieved. We identify the set of endowment allocations for which the subsidy rate to one region is higher (or lower) than the subsidy rate to the rival. The large poor region receives a higher subsidy than the small rich region, but the subsidy to the small poor region may be higher or lower than that to the large rich region. [H2]     

Choice and design of regulatory instruments in the presence of green consumers

Using a vertically differentiated product model, this paper examines welfare implications of various government policies in a situation where consumers are environmentally discerning. It studies ad valorem taxes/subsidies and emission taxes. The optimal policy depends on the magnitude of damage parameter associated with environmental externality. For a given distribution of tastes and preferences, as the damage parameter increases from a low to a high value, the optimal policy shifts from an ad valorem tax to an ad valorem subsidy. It also shows that for a sufficiently low damage parameter, an ad valorem tax dominates an emission tax.     

Frontiers of Climate Change Economics

The potential of taxes to correct environmental externalities has long been recognized among economists. Yet, this welfare-enhancing policy commonly faces strong opposition by citizens. Conversely, externality-correcting subsidies frequently enjoy high public support. We conduct a lab experiment to explore public support for Pigouvian taxes and subsidies. In an experimental market with a negative externality, participants vote on the introduction of Pigouvian taxes and subsidies under full or reduced information concerning how the tax revenues will be spent and the subsidy paid for. Theoretically the two instruments should produce identical outcomes. However, we find substantially greater support for subsidies than for taxes. This can partially be explained by the participants’ expectation that the subsidy will increase their own payoffs more than a tax, but not because it is expected to be more effective in changing behavior. Furthermore, we find that with greater uncertainty, the preference for subsidies is even stronger, a result which is consistent with loss aversion.     

Optimal tax rules and public sector efficiency with an externality in an overlapping generations model

This paper examines optimal tax rules and public sector efficiency, integrating them in a second-best world with pollution by using an overlapping generations model. The second-best world is characterized by the comparative statics of green preferences. The main results obtained are as follows. First, the marginal cost of public funds may be reduced by the externalities, regardless of the choice of taxes. Second, optimal environmental and non-environmental tax rules are additively and directly affected by the dynamic efficiency of capital accumulation per unit labour (DECAL), and indirectly by it, through the efficiency of the public sector. Environmental taxes going beyond Pigovian ones may be welfare-improving if the DECAL is improved by the environmental tax. Even optimal non-environmental tax rules should additively and directly counter the dynamics of pollution to consider the income effects of the optimal tax system for the future. Third, the “additivity property,” or the “principle of targeting,” does not hold even in the absence of incentive compatibility constraints. The essential reasons for this are clarified as follows: distortions that should be countered by taxes; that is, the income effects of the optimal tax system and the DECAL in this model, break the equality between optimal environmental taxes and the externalities measured by governments. Finally, growing environmental concerns may, in fact, increase pollution. The inverse relationship between environmental and labour income taxes may not hold.     

Environmental Tax Reform and Government Expenditure

In a simple model of production with an imported polluting resource and involuntary unemployment we consider the effects of energy taxes, holding the real wage constant, under differing levels of government expenditure and externalities. Simulations reveal conflict between the goals of net welfare, employment and profitability over much of the relevant parameter range, thus extending the usual discussion of multiple dividends. However, potential net welfare and employment gains are substantial for plausible parameters. The optimal energy tax declines as government expenditure rises and is less than the Pigovian tax for plausible externalities.     

“More is less”: the tax effects of ignoring flow externalities

Using a model of non-linear, non-monotone decay of the stock pollutant, and starting from the same initial conditions, the paper shows that an optimal tax that corrects for both stock and flow externalities may result in a lower tax, fewer cumulative emissions (less decay in emissions) and higher output at the steady state than a corrective tax that ignores the flow externality. This “more is less” result emphasizes that setting a corrective tax that ignores the flow externality, or imposing a corrective tax at too low a level where there exists only a stock externality, may affect both transitory and steady-state output, tax payments and cumulative emissions. The result has important policy implications for decision makers setting optimal corrective taxes and targeted emission limits whenever stock externalities exist.     

Unequal Longevities and Lifestyles Transmission

Whereas studies on the optimal taxation under endogenous longevity assume a fixed heterogeneity of lifestyles, this paper analyses the optimal tax policy in an economy where unequal longevities are the unintended outcome of differences in lifestyles, and where lifestyles are transmitted across generations. For that purpose, we develop a three-period OLG model where the population, who ignores the negative impact of excessive work on longevity, is partitioned in two groups with different tastes for leisure, and follows an adaptation/imitation process  à la   Bisin and Verdier (2001) . The optimal short- and long-run Pigouvian taxes on wages are shown to differ, because the latter correct agents' myopia, but also internalize intergenerational externalities due to the socialization process. The internalization of composition effects raises the Pigouvian tax on the wage of one type of agents, but reduces it on the other type, in such a way as to induce the optimal long-run partition of the population.     

Environmental quality,the macroeconomy,and intergenerational distribution

The paper studies the dynamic allocation effects and intergenerational welfare consequences of environmental taxes. To this end, environmental externalities are introduced in a Blanchard–Yaari overlapping generations model of a small open economy. A rise in environmental taxes – taking into account pre-existing distortionary taxes and endogenous labor supply – is shown to yield an efficiency gain if agents care enough for the environment. The benefits are unevenly distributed across generations because agents are heterogeneous in their capital ownership. An accompanying debt policy can be designed – prescribing debt accumulation at impact and debt redemption in the new steady state – to ensure everybody gains to the same extent. With lump-sum recycling of environmental tax revenue, aggregate employment is unaffected in the short run, but falls in the long run. Furthermore, it raises environmental quality more in the long run than in the short run. Recycling revenue through a cut in labor taxes, however, is shown to yield a rise in employment in the short run, which disappears during transition. In the new steady state, environmental quality is higher at the expense of a lower level of employment.     

Social Comparisons and Optimal Taxation in a Small Open Economy

In this paper, we analyze how international capital mobility affects the optimal labor and capital income tax policy in a small open economy when consumers care about relative consumption. The main results crucially depend on whether the government can tax returns on savings abroad. If the government can use flexible residence‐based capital income taxes, then the optimal policy rules from a closed economy largely carry over to the case of a small open economy. If it cannot, then capital income taxes become completely ineffective. The labor income taxes must then indirectly also reflect the corrective purpose that the absent capital income tax would have had.     

Keeping up with the Joneses, consumer ethnocentrism, and optimal taxation

This paper sets up a two-good (domestically- and internationally-produced goods) model of a small open economy with consumption externalities and uses it to examine the optimal taxation. Since keeping up with the Joneses leads an individual consumption's to impose a negative externality on the consumption of others, a consumption tax and tariff are thereby socially desirable to correct this distortion. Due to the fact that the government has to account for additional distortion caused by consumer ethnocentrism and that keeping up with the Joneses in the consumption of domestic goods tends to reinforce the influence of ethnocentrism on the purchase of domestic products, the consumption of imported goods is subject to a higher tariff rate because of the cross-market externality. Of interest, if consumption only involves an own-market externality, there is no cyclical consequence for the optimal taxes. However, if consumption involves both own- and cross-market externalities, the optimal tariff is state-contingent and, more specifically, is countercyclical.