Environmental policy in a two sector growth model

This paper analyses policy measures within a two sector endogenously growing economy with pollution. Pollution is either generated by production or by the use of physical capital in production, and can be reduced by public abatement activities. In this generalized Uzawa Lucas model, the effects of fiscal policy are derived for all core variables and ratios. In addition, the optimal taxation rules are derived. If a pollution tax is not available it turns out that a first best solution may be reached by use of factor income taxation. Additionally, the effects and the possibility of environmental policy are complemented for a small open economy.