TY  - JOUR
AU  - Fullerton,Don
AU  - Wolverton,Ann
TI  - The Two-Part Instrument in a Second-Best World
JF  - National Bureau of Economic Research Working Paper Series
VL  - No. 10140
PY  - 2003
Y2  - December 2003
UR  - http://www.nber.org/papers/w10140
L1  - http://www.nber.org/papers/w10140.pdf
N1  - Author contact info:
Don Fullerton
Department of Finance
University of Illinois
BIF Box#30 (MC520)
515 East Gregory Drive
Champaign, IL  61820
Tel: 217/244-3621
Fax: 217/244-3102
E-Mail: dfullert@illinois.edu

Ann Wolverton
National Center for Environmental Economics
U.S. Environmental Protection Agency
1200 Pennsylvania Ave., NW
MC 1809T
Washington, DC 20460
E-Mail: wolverton.ann@epamail.epa.gov
AB  - The standard theory that the first-best tax on pollution is equal to marginal environmental damages has been extended in two directions. First, many polluting activities are difficult to tax because they are not market transactions, and so recent papers have shown that the same effects can be achieved by use of a two-part instrument    a tax on one market transaction such as output or income and a subsidy to a different market transaction that is a clean alternative to pollution. It is a generalization of a deposit-refund system. Second, a different literature concerns the second-best optimal pollution tax in the presence of other tax distortions. Here, we combine the two extensions by looking at the second-best two-part instrument (2PI). When government needs revenue, is the deposit larger and the rebate smaller? We find explicit solutions for each tax and subsidy in a general equilibrium model with other tax distortions, and we compare these to the rates in a first-best model. The tax-subsidy combination is explained in terms of a tax effect, an environmental effect, and a revenue effect. The model allows for flexible interpretation, to show various applications of the 2PI. We also discuss important caveats, cases where the 2PI may not be appropriate.
ER  -