Abstract
This paper investigates the consequences of environmental tax reforms for unemployment and welfare, in the case of developing countries with a large informal sector, rural–urban migration, and three different assumptions about public spending: (1) as part of a revenue-neutral policy, (2) fixed, and (3) varying endogenously. Under the indexation of unemployment benefits and informal-sector income that give rise to a double dividend, a lower level of public spending is associated with a smaller negative impact on the after-tax income of households and a higher increase in employment. These policies, however, still lead to a reduction in social welfare; even more so in the case of endogenous public spending, although it is associated with a higher increase in employment and a smaller reduction in private-sector incomes. The model implies that complementary policy, in terms of lower public spending, is unlikely to be socially acceptable, and does not support the case for a green tax reforms in developing countries.
Highlights
Environmental tax reform is one of the most effective tools that can be used in a fundamental transformation towards a green economy
I evaluate the welfare implications of two environmental tax reforms under a taxation scheme that gives rise to a double dividend,2 and under the assumption of either fixed or varying public spending
Comparing columns (2)–(4) across tables, we see that for a given level of environmental taxation, equivalent variation (E V) is lower when public spending varies endogenously compared to when public spending is fixed, even though the former policy is associated with a larger increase in incomes of both formal and informal workers, as discussed in the previous section
Summary
Environmental tax reform is one of the most effective tools that can be used in a fundamental transformation towards a green economy. To make green tax reforms socially acceptable, economists have argued that complementary policies such as public spending cuts could be used to reduce the environmental tax burden on private sector income (see Koskela and Schob 1999; Bovenberg 1995). Workers in the informal sector search for jobs in the formal sector, and the unemployment rate is defined as the proportion of the labour force that is in informal-sector self-employment The economy imports both energy and capital at given world prices to use as inputs in registered production activities. I find that the income of agricultural workers fall under all policy scenarios, even though they do not pay energy taxes This is because the higher burden of taxation imposed on the unemployed prompts them to escape the brunt of taxation by searching for a job in the formal sector or by migrating into rural areas. Revenues collected from taxing energy and labor are used to provide general government goods and transfers to the unemployed
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