Environmental Policy in a Tax-Distorted EconomyEPA Grant Number: U915182
Title: Environmental Policy in a Tax-Distorted Economy
Investigators: Williams, Roberton C.
Institution: Stanford University
EPA Project Officer: Lee, Sonja
Project Period: January 1, 1997 through January 1, 2000
Project Amount: $102,000
RFA: STAR Graduate Fellowships (1997) RFA Text | Recipients Lists
Research Category: Academic Fellowships , Economics and Decision Sciences , Fellowship - Economics
The objective of this research project is to extend the literature on environmental tax interactions by: (1) examining the effect on the costs of a broader set of policies than just taxes or quotas, such as performance standards and mandated technologies; (2) considering how the benefits of reduced pollution also will be altered in a tax-distorted economy, particularly when pollution affects consumer health or worker productivity; (3) considering the effect of tax interactions in an economy where production uses both capital and labor as inputs (rather than using labor alone, as the previous literature has assumed); and (4) examining the role of uncertainty about benefits and costs in this setting, and how it alters the relative costs and benefits of different types of policies. Recent studies have shown that the costs of pollution taxes and quotas can be dramatically changed when taxes (such as the income tax) distort other markets. This difference arises because environmental regulation tends to boost the price of consumption goods, thereby discouraging labor supply and exacerbating the distortion from the income tax. For pollution quotas, this effect substantially increases the cost of regulation. Pollution tax revenues can be used to cut other taxes, providing an offsetting efficiency gain, but even for pollution taxes, the cost of regulation is higher in a tax-distorted economy.
The early stages of this project used simple static analytical and numerically solved general equilibrium models, which incorporate production of both polluting and nonpolluting goods. These models incorporated a representative agent, who allocates time between labor and leisure, and a government sector, which provides transfer payments funded by a distortionary tax on labor. To analyze the effect of interactions between environmental policy and capital taxes, a more complex model was necessary. This model is fully dynamic, incorporating individual savings, which finance capital investment, and the government taxes capital as well as labor.