Rotterdam Brown Bag Seminars General Economics

Bas Jacobs (Erasmus University Rotterdam)
Wednesday, April 20, 2016

Should redistributive governments set lower pollution taxes if the poor spend a large fraction of their income on polluting goods? We show that, even if governments are interested in income redistribution and can employ an optimal linear income tax, optimal corrective pollution taxes should be set exactly at the first-best Pigouvian tax if utility functions of households belong to the Gorman polar form. Demand for polluting goods then features a linear Engel curve. This is the case for quasi-linear, CES, Stone-Geary, and other commonly used utility functions. Consequently, even if the poor spend a disproportionate fraction of their disposable income on polluting goods the optimal pollution tax is still Pigouvian. Moreover, if utility functions belong to the Gorman polar class, Pareto-improving green tax reforms exist that move the pollution tax closer to the Pigouvian rate, while ensuring that net incomes of individuals are unaffected. Empirically, preferences do not belong to the Gorman polar class, since Engel curves for polluting commodities are not linear. To explore whether deviations from Pigouvian taxes are desirable for income redistribution, we simulate our model using PIGLOG preferences where polluting goods are necessities.

Coauthor: Frederick van der Ploeg