ON GREEN PRODUCTION TAXES

Proposals are often made to tax goods which are environmentally damaging. Manysuch goods are consumed both directly by households and industry at large: for example,carbon-intensive fuel, waste water or congested road space. This paper adopts a tax-reformsetting to evaluate such a policy. The welfare impact is shown to depend on an inputsubstitutioneffect and an output effect on final consumption, where the latter effect can beconveniently analysed via the standard concept of the marginal welfare cost of a commoditytax. Finally, it is shown that raising a production tax is welfare enhancing if the current tax isbelow marginal external cost and revenues are recycled via the commodity tax with thehighest marginal welfare cost....