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Optimal Control of Externalitiesin the Presence of Income Taxation
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LOUIS KAPLOW
Harvard Law School; National Bureau of Economic Research (NBER)
June 2006
Harvard Law and Economics Discussion Paper No. 547
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Abstract:
A substantial literature examines second-best environmental policy, focusing particularlyon how the Pigouvian directive that marginal taxes should equal marginal external harms needsto be modified in light of the preexisting distortion due to labor income taxation. Additionalliterature is motivated by the possibility that distributive concerns should amend theinternalization prescription. It is demonstrated, however, that simple first-best rules - unmodified for labor supply distortion or distribution – are correct in a natural, basicformulation of the problem. Specifically, setting all commodity taxes equal to marginal harms(and subsidies equal to marginal benefits) can generate a Pareto improvement. Likewise, amarginal reform in the direction of the first-best can yield a Pareto improvement. For otherreforms, a simple efficiency test characterizing when a Pareto improvement is possible is offered. Qualifications and explanations for the substantial departure from results in previous work arealso elaborated.
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JEL Classifications: D61, D62, D63, H21, H23, K32
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Working Paper Series
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Suggested Citation
Kaplow, Louis, "Optimal Control of Externalitiesin the Presence of Income Taxation"
(June 2006).
Harvard Law and Economics Discussion Paper No. 547 Available at SSRN: http://ssrn.com/abstract=921430
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Contact Information for
LOUIS
KAPLOW
(Contact Author)
Email address for LOUIS
KAPLOW
Harvard Law School
1575 Massachusetts Avenue
Cambridge
, MA
02138
United States
617-495-4101 (Phone)
617-496-4880 (Fax)
(No e-mail address available for LOUIS
KAPLOW
National Bureau of Economic Research (NBER)
1050 Massachusetts Avenue
Cambridge
, MA
02138
United States
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