Corrective Taxes and Pollution Abatement

Abstract

IT has been over 50 years since the idea of a corrective tax was first suggested by Pigou. Yet there is still some confusion over exactly what should be taxed.' Henderson and Quandt argue that the corrective tax should be placed on the output of the industry responsible for the pollution.2 Mishan also believes that an output tax (or the presence of monopoly power in the product market) can be corrective.3 Plott has argued that in no case can Pareto optimality be achieved by an output tax; only a tax on the responsible input or the pollutant can do that.4 The purpose of this paper is to demonstrate that Pareto optimality can be achieved in all instances only by placing the tax on the pollutant. Specifically, I shall show that: (1) Pareto optimality cannot be achieved in the face of external diseconomies simply by effecting a reduction in the output of the polluting industry. Thus, output taxes or monopoly power, since they only can change industry output, cannot achieve Pareto optimality. (2) One of the conditions for Pareto optimality must be that abatement inputs are being used efficiently, that is, the wage of each abatement input must be equal to the value of its marginal product in abatement. (3) Since neither input nor output taxes make abatement profitable, this condition can only be achieved by placing the tax on the pollutant.