Does Environmental Taxation Increase Employment? Limitations and a Survey about the current Debate of the Double Dividend Hypothesis

1. INTRODUCTION

Economic analysis has played a key role in the evaluation of a green tax reform – the reorienting of the system to concentrate taxes more on „bads“ like pollution and less on „goods“ like labor effort. Economic science often use a general equilibrium framework, an approach that considers how environmental policies affect not only the targeted firms or industries but the rest of the economy as well [4]. In recent years there has been a good debate among economics and politicians about the interactions between environmental politics and the constisting tax system. The discussion lifted up in response to the so-called „double dividend“. That‘s the claim that environmental taxes could simultaneously improve the environment and reduce the economic cost of distortionary taxes and thereby to produce incentives for more employment. The double dividend discussion has produced an amount of theoretical and empirical research. The basics behind this results is that environmental taxes induces new market distortions, similar to those of the replaced taxes [2].

Keywords: Green Tax, Double Dividend, Equilibrium Framework

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* Acknowledgements: Much of this is based on a background paper by Prof. Joachim Weimann. I would like to thanks for his great ideas. The recent debate about green taxation was one more intention for this paper. I am especially indebted to Dr. David Mahana (Catholic University of Chile) for helpful discussions. However, all interpretations and errors are mine.

2. WELFARE ISSUES

Figure 1 provides a textbook analysis of a tax-caused welfare loss. In this simple example an output tax tO distorts the demand and supply decision. The exsess burden can be visualized as the change A. The revenue of tax is evaluated as B. An existing revenue of taxes B provides an opportunity of reduction of distortionary taxes, for instance in a lump-sum return to the economy.

Figure 2 illustrates this idea for example of labor taxation, where the tax wedge tL0 distorts the supply and demand decision on the labor market [3]. When the revenue of tax tE in Figure 1 is used to cut the labor tax rate from tL0 to tL1, labor market distortions are reduced and employment increased. In this example the second dividend of a fictional reform can be derived as the aggregate change of welfare losses on the market subject to the tax tE (see Figure 1) and the labor market (see Figure 2). The recycling of an additional tax revenue is called the „revenue-recycling-effect “ [2].

Does the double dividend indeed arise? Using revenues from green taxes to finance cuts in distortionary taxes does avoid some of the distortions that these pre- existing taxes would generate otherwise. This implies an welfare benefit, which was called the „revenue-recycling-effect“ [2]. Because of the positive revenue-recycling effect, the cost of a green tax reform will be lower when the revenues from such a tax are used to finance cuts in distortionary taxes than, when the revenues are returned to the economy in a lump-sum fashion – for example, through lump-sum transfers to households. This doesn’t mean that the cost are negative, which is the requirement for the dividend to occur. Are the cost of a green tax negative? Several models suggest that the answer is no [2,4,]. These models indicate that a green tax is a relatively inefficient way to raise revenues.

Separating out three components of the cost of a green tax reform makes it easier to understand the requirements for obtaining the dividend. The first component is the

„primary cost“ [2] of environmental tax, that is the direct cost associated with changes in production methods or installation of pollution-abatement equipment required to reduce pollution. The second component, which is mentioned earlier, is the „revenue-recycling effect“ [2]. And the third component is called the „tax-interaction effect“ [2], which can explained as follows: to the impact of raising producers‘ cost they imply higher prices of commodities. This effectivly reduces the real returns to factors and with them it generates less purchasing power.