Pollution, mortality and optimal environmental policy

We study an overlapping generations economy in which environmental degradation results from economic activity and affects agents' uncertain lifetimes. Life expectancy depends positively on economic activity and negatively on the stock of pollution. This can make the growth-survival relationship convex over some region and lead to two non-trivial steady states, with one a poverty trap. Uniform abatement taxes can cause the poverty trap to widen while increasing incomes at the high steady state. We also study the properties and dynamics of an optimal second-best abatement tax. It is non-homogeneous and increasing in the capital stock, and leads to a variety of dynamic possibilities, including non-existence and multiplicity of steady states, and cycles around some of the steady states, where there were none under exogenous taxes. Thus, optimal taxes can be an independent source of non-linearities.