The (Non-)Equivalence of Input and Output Taxes under Monopoly.

The author argues that a government taxing a polluting monopoly by means of levies on output and inputs can implement the first-best allocation through a continuum of tax profiles. Using this degree of freedom in the tax system, the government is, in general, able to transfer income from the firm to the public sector, so that the additional tax rate acts as a non-distorting tax on profits. This transfer--and therefore public revenue--is the higher, the lower (higher) the input taxes are, and correspondingly the higher (lower) the output tax is, provided that the production function exhibits decreasing (increasing) returns to scale. Copyright 2001 by Blackwell Publishing Ltd and the Board of Trustees of the Bulletin of Economic Research