Environmental taxes and unemployment in Europe

Abstract

A number of countries in the EU suffer from two major problems. First, the social and economic problems associated with high unemployment rates and, second, the degradation of natural environments. In the light of both of these problems, environmental tax reforms have been widely discussed in the EU. Indeed, some economists have argued that environmental tax reforms may contribute to reduce unemployment and, at the same time, improve the quality of the environment, thus yielding a so-called 'double dividend' . Other economists, however, have raised doubts on the double-dividend argument. In their view, such a tax reform is not likely to cut unemployment rates. This paper explains that this conflict among economists originates from the difference in methodology, namely, partial equilibrium vs. general equilibrium approaches. In particular, the double-dividend conclusion from the partial equilibrium approach may be misleading because, unlike the general equilibrium analysis, it ignores the interactions between markets. Although general equilibrium models have often been used to show that the double-dividend hypothesis may fail, they also provide insights that unemployment can fall due to an environmental tax reform. However, such a double dividend is typically associated with a shift in the income distribution from people outside the labor market towards the insiders. This change in the income distribution makes it very difficult politically to impose environmental taxes. Hence, concentration on the unemployment argument may frustrate the introduction of environmental taxes because the reduction in unemployment is typically associated with political tendencies due to a change in the income distribution. The best strategy to limit political obstacles seems to be one in which the income distribution is maintained. This can be achieved by using the revenues from environmental taxes to compensate people who bear the burden of the environmental taxes. Such a revenue-recycling strategy is generally different from one that concentrates on reducing unemployment.