TY  - JOUR
AU  - Kaplow,Louis
TI  - Optimal Control of Externalities in the Presence of Income Taxation
JF  - National Bureau of Economic Research Working Paper Series
VL  - No. 12339
PY  - 2006
Y2  - June 2006
UR  - http://www.nber.org/papers/w12339
L1  - http://www.nber.org/papers/w12339.pdf
N1  - Author contact info:
Louis Kaplow
Harvard University
Hauser 322
Cambridge, MA  02138
Tel: 617/495-4101
Fax: 617/496-4880
E-Mail: meskridge@law.harvard.edu
AB  - A substantial literature examines second-best environmental policy, focusing particularly on how the Pigouvian directive that marginal taxes should equal marginal external harms needs to be modified in light of the preexisting distortion due to labor income taxation. Additional literature is motivated by the possibility that distributive concerns should amend the internalization prescription. It is demonstrated, however, that simple first-best rules %u2013 unmodified for labor supply distortion or distribution %u2013 are correct in a natural, basic formulation of the problem. Specifically, setting all commodity taxes equal to marginal harms (and subsidies equal to marginal benefits) can generate a Pareto improvement. Likewise, a marginal reform in the direction of the first-best can yield a Pareto improvement. For other reforms, a simple efficiency test characterizing when a Pareto improvement is possible is offered. Qualifications and explanations for the substantial departure from results in previous work are also elaborated.
ER  -