Abstract
This paper builds a small open economy trade model where there is pollution from the production and consumption of goods. In the presence of production and consumption pollution, we examine a piecemeal consumer-price-neutral reform of the tariff and consumption tax and a piecemeal producer-price-neutral reform of the export and production taxes on a specific good. The paper identifies sufficient conditions under which the above tax reforms improve welfare and increase government tax revenues.
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Notes
Kreickemeier and Raimondos-Møller (2008) examine whether a consumer-price-neutral uniform reduction in tariffs and increase in consumption taxes improves the market access of a small open economy. Moreover, they note that such a reform scheme is less efficient; both in terms of welfare and market access considerations, compared to a reform of only tariffs (e.g., see Ju and Krishna 2000). For the welfare and market access implications of tariff reforms, see, among others, Anderson and Neary (2007).
Keen and Ligthart (2002), among others, examine the welfare and tax revenue implications of the aforementioned tax reforms in the context of perfectly competitive models. There is, however, a literature concluding that under imperfect competition there are cases whereby unambiguously welfare improving reform programs under perfect competition can become welfare worsening, e.g., Davies and Paz (2011).
We follow a standard practice of the literature of indirect tax reforms, which, for analytical convenience confines the analysis of such tax reforms in the context of small open economies.
Using ad-valorem taxes produces qualitatively similar results to the ones we derive here.
Often, the R(p) function is referred to as GNP or GDP function, capturing an economy’s maximum revenues from the production of private goods given its (fixed) stock of factor endowments.
The E(.) function is increasing in z and r since an increase in any type of pollutant is assumed to harm the households’ utility. Therefore, to attain a given level of utility, u, private spending on consumption must rise. Moreover, E u (=∂E/∂u) denotes the reciprocal of the marginal utility of income.
Beghin et al. (1997) assume that production and consumption activities generate a single type of pollutant, in which case aggregate pollution in the economy is defined as the sum T=α′R p (p)+β′E q (q,p,T,u). A more general specification would allow for different types of pollutants, at different rates, for every unit of the j th output produced and consumed. In this case, z,r respectively are vectors of production and consumption pollutants with elements \(z_{j} = \alpha_{j}R_{p_{j}}(p)\) and \(r_{j} = \beta_{j}E_{q_{j}}(q,r,z,u)\) for every j th commodity. This latter specification results to quite cumbersome algebraic calculations without adding substantively to the generality of the results.
When pollution is generated from production, our vector of production taxes (s) is equivalent to the vector of pollution taxes (s) in Copeland (1994). When pollution is generated from consumption, consumption taxes (t) are equivalent to pollution taxes.
The positive sign of Λ is justified in various ways. Here Λ −1 is the tax multiplier, equivalent to the so-called tariff multiplier, for example in Copeland (1994), Neary and Ruane (1988). A negative multiplier would imply that an increase in lump-sum taxes on consumers would raise utility. Alternatively, by the homogeneity of degree one of the expenditure function in consumer prices, q′E qu =E u . Then, Λ=p ∗′ E qu , and is positive since all goods are assumed normal in consumption, e.g., see Emran (2005).
Subscripts on the functions, i.e., E qp , E qz , E qr , E qu and R pp denote partial derivatives. For example, E qq =∂E q /∂q, R pp =∂R p /∂p.
For example, let the k th good be an imported commodity, and dτ k <0 and dt k >0, so that dq k =dt k +dτ k =0. This reform implies an increase (decrease) in the net production tax (subsidy) on the k th good. Production of this commodity falls, and so does production generated pollution. Given that θ k is positive, and assuming that clean environment is substitute to all goods in consumption, i.e., all elements of the E qz vector are positive, then consumption of all commodities rises and tax revenues increase by \(\alpha_{\iota} \theta'E_{q_{k}z}\), leading to an overall positive tax revenue effect.
Writing overall pollution as \(z = \alpha_{k}R_{p_{k}}(p) + \sum_{j \ne k} \alpha_{j}R_{p_{J}}(p)\), differentiating with respect to τ k , and using the homogeneity properties of the output supply functions, we obtain (7).
Since we denote an export tax by τ i <0, a reduction of its size implies that, algebraically, τ i rises.
Emran (2005) examines the effects of the same reform on welfare and revenue in an economy where the administration of taxes is costly but there is no pollution.
With only consumption pollution, the consumer-price-neutral reform in tariffs and consumption taxes leads to dr=δ −1 β′E qu du. Then, had δ being negative, an increase in income and consumption would result to a lower level of consumption generated pollution.
In this case, for given taxes, producer and consumer prices, using (1) and (2), we get that (E u −θ′E qu ) du=−(E r −θ′E qr ) dr. Thus, the term (E r −θ′E qr ) must be positive for an increase in pollution to reduce welfare. Thus the assumptions that goods (i) are normal in consumption, (ii) an increase in consumption of goods increases pollution and (iii) the increase in pollution reduces welfare (given everything else) are sufficient conditions for Δ to be positive.
The assumption that the demand for goods is independent of the environmental quality is often made in the literature (i.e., Bovenberg 1999; Beghin and Dessus 1999). In the analysis to follow we assume E qr =E qz =0 while E qu >0. This result emerges if the expenditure function has the following form \(E(q,u,z,r) = g(q)\bar{u} + z + r\). Among others, Wilson (1991) considers an example of a direct utility function and Copeland and Taylor (2004) an example of an indirect utility function by which ordinary, not compensated, demand functions for goods are independent of public good and pollution, respectively. Lahiri and Raimondos-Møller (1998) discuss the implications of zero income effects on the non-numeraire commodity and of the separability between private and public goods in consumption. Hatzipanayotou et al. (2008) also discuss the (non-)separability between private goods and clean environment in consumption.
It can be easily shown that in the presence of only consumption pollution, the effect of the producer-price-neutral reduction in export taxes on the level of pollution is give by \(\delta(dr/\tau_{k}) = \beta 'E_{qu}(du/d\tau_{k}) + \sum_{j \ne k} [(\beta_{j}/q_{j}) - (\beta_{k}/q_{k})] q_{j}E_{q_{j}q_{k}}\). Thus, the reform that increases welfare may also increase pollution. Therefore, the conditions that the k th good (i) is a substitute to all other goods in consumption and (ii) it carries the highest rate of pollution per unit of consumption as a fraction of its consumer price, is necessary but not sufficient for the welfare improving reform to reduce pollution.
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Acknowledgements
We thank B. Copeland, P. Neary, P. Raimondos-Møller, P. Sgro, E. Yu, the participants of the Workshop on Growth, Trade and Environment at the Venice International University, June 2008, and of ETSG 2007, the editor and the two anonymous referees of the Journal for useful comments and suggestions. For remaining shortcomings the authors are solely responsible.
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Michael, M.S., Hatzipanayotou, P. Pollution and reforms of domestic and trade taxes towards uniformity. Int Tax Public Finance 20, 753–768 (2013). https://doi.org/10.1007/s10797-012-9241-0
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DOI: https://doi.org/10.1007/s10797-012-9241-0
Keywords
- Domestic and trade tax reforms
- Production and consumption generated pollution
- Government tax revenues
- Welfare