The Macroeconomic Effects of Environmental Taxes: A Closer Look At the Feasibility of "Win-Win" Outcomes

Abstract

The linkages between environmental protection, public finance instruments, and macroeconomic objectives have been barely addressed in the literature until this last decade. This paper surveys recent developments in the theoretical and empirical literature on the macroeconomic effects of environmental taxes. An attempt is made to delineate the conditions under which environmentally motivated fiscal policies yield "win-win" outcomes in the sense that they improve environment quality as well as attain macroeconomic objectives, such as more employment or a higher rate of economic growth. Traditional theoretical work on environmental policy starts from a microeconomic framework focusing on a particular market that features an environmental externality. Various policy instruments are discussed and evaluated in terms of economic efficiency. Compared with standards, environmental taxes are a lower cost instrument to achieve a given level of pollution. In this type of model, however, the revenues of environmental taxes are rebated to consumers in a lump-sum fashion. Revenues from environmental taxes may be employed in a more productive way by using them to lower distortionary taxes on labor in a revenue-neutral manner. Such a green fiscal reform may yield a "double dividend"—boosting both environmental quality and employment—if the burden of taxation can be shifted to agents outside the labor market, such as capital owners, transfer recipients, and foreigners.