Greening the Tax System

• Author: Muthukumara Mani
• Pages: 12-

Page 12

Pigovian environmental taxes, set at the level of marginal social damage, have the advantage of inducing firms and individuals to reduce pollution at the level where the costs of doing so are the least. ¹ Ligthart (1998a) analyzes the question of how to set optimal fiscal policy when the tax system must perform the dual task of internalizing externalities, on the one hand, and raising revenue to finance public goods, on the other. The second-best optimal environmental tax is, surprisingly, shown to lie below the first-best Pigovian tax, as preexisting tax distortions exacerbate the overall efficiency costs of an incremental increase in the pollution tax. ²

The use of revenues from such taxation practices has also come under scrutiny. Ligthart (1998b) concludes that using the revenues from environmental taxes to cut other taxes may yield employment and environmental dividends if the tax burden can be shifted to agents outside of the labor market, such as onto capitalists, transfer recipients, and foreigners. ³ In practice, however, instead of being used to secure a "double dividend" by also reducing distortionary taxes, revenues from environmental taxes often seem to be earmarked for particular spending programs. Brett and Keen (2000) argue from a political economy perspective that earmarking funds for announced programs-usually ill-advised on efficiency grounds-may enable politically weak "green" politicians to amenably raise environmental tax revenues in the face of political uncertainty. ⁴

The environmental implications of trade have also received considerable attention. Fredriksson and Mani (2001) develop a political economy framework to show that trade integration, in general, increases environmental taxes by reducing industry lobbying efforts. However, in order to realize the full effects of trade liberalization, they argue that the political system needs to be relatively stable. ⁵ The use of trade measures such as tariffs and export taxes or outright bans for promoting environmental objectives has also been analyzed. In a recent study on Costa Rica, Kishor, Mani and Constantino (2001) show that eliminating log-export bans could generate considerable economic as well as environmental benefits, provided the resulting increased demand is met from sustainably managed forests. ⁶

Taxation-based approaches to environmentally sound forest management have also been studied. Leruth, Paris, and Ruzicka (2001) argue that, given the...