On the Double Dividend of Environmental Taxation

An income tax is equivalent to a uniform tax on all expenditures, including expenditures on commodity tax payments. This will compound the tax being applied to any taxed commodity. In the presence of an income tax, therefore, any expenditure tax (including a pollution tax) will produce a higher effective tax than its nominal tax rate would suggest. For example, a nominal Pigouvian tax applied to a polluting good will be equivalent to an effective tax higher than this. These observations are used to shed light on recent debate surrounding the double dividend hypothesis. From this vantage point, the present analysis finds that the double dividend hypothesis is valid and that the optimal effective pollution tax is always the Pigouvian rate, although the presence of an income tax implies a correspondingly lower nominal pollution tax rate. The analysis also concludes that second-best optimal taxation implies a cleaner, not a dirtier, environment than for the first-best case, and that a higher marginal cost of public funds will raise the optimal tax on polluting goods and lower the optimal level of pollution.