Evaluating policy interventions with general equilibrium externalities

This paper describes a method for quantifying the effects of nonseparable externalities (or public goods) on public policies with important general equilibrium consequences. We calibrate a general equilibrium model with nonseparable air quality benefits in order to measure the excess burden and total net benefits of a new energy tax in the 1995 U.S. economy. With and without the nonseparable air quality responses, our excess burden estimates for a new 5% energy tax (with a pre-existing 40% income tax) differ from 6-27% when air quality is assumed to be twice as substitutable with leisure as the average good. We find similar, but larger differences (11-37%) when the goods are assumed to be strong complements. The magnitude of these effects and the asymmetry across the substitution patterns are due in large part to the character of the general equilibrium feedbacks that the externality produces.