Environmental Controls, Scarcity Rents, and Pre-Existing Distortions

Abstract

Debate about the Double Dividend Hypothesis has focused on whether an environmental policy raises revenue that can be used to cut other distorting taxes. In this paper, we show that this focus is misplaced. We derive welfare results for alternative policies in a series of analytical general equilibrium models with clean and dirty goods that might be produced using emissions as well as other resources, in the presence of other pre-existing distortions such as labor taxes or even monopoly pricing. We show that the same welfare effects of environmental protection can be achieved, without exacerbating the labor distortion, by taxes that raise revenue, certain command and control regulations that raise no revenue, and even subsidies that cost revenue. Instead, the pre-existing labor tax distortion is exacerbated by policies that generate privately-retained scarcity rents. These rents raise the cost of production, raise equilibrium output prices, and thus reduce the real net wage. Such policies include both quantity-restricting command and control policies and certain marketable permit policies.