Tax Deductions, Environmental Policy, and the “Double Dividend” Hypothesis

Recent studies find that environmental tax swaps typically exacerbate the costs of the tax system and therefore do not produce a “double dividend”. We extend previous models by incorporating taxfavored consumption goods (e.g. housing, medical care). In this setting, the efficiency gains from recycling environmental tax revenues are larger because pre-existing taxes distort the consumption bundle, besides distorting factor markets. We find that a revenue-neutral emissions tax (or auctioned permits) can produce a significant double dividendindeed the economic costs of modest emissions reductions may be negative. The efficiency gains from emissions taxes over grandfathered permits are also larger than previously recognized.