Environmental taxes and labor-market distortions

It is sometimes argued that by using the revenues from environmental taxes to reduce distortionary taxes on labor, governments can reap a ‘double dividend’, namely, not only an improvement in environmental quality, but also a reduction in the efficiency costs associated with raising public revenue. By employing a general equilibrium model, this paper finds that, contrary to common wisdom, environmental taxes typically render the overall tax system a less efficient instrument to finance public spending. Furthermore, high estimates for the marginal efficiency costs of existing taxes weaken, rather than strengthen, the case for environmental taxes.