A Second-Best Analysis of Environmental Subsidies

This paper examines the complications posed by pre-existing tax distortions in the economy, for the evaluation of a variety of subsidy policies that affect the environment. These complications include not only the efficiency cost of financing the subsidy by distortionary taxation, but also the interaction effects between the subsidized market and markets with pre-existing taxes. Studies that ignore both of these effects, or only incorporate the first type of effect, can be highly misleading.