Abstract
This paper attempts to integrate the theory of optimal taxation with the analysis of the use of indirect taxation to counteract negative external effects (Pigovian taxes). A first-best solution to the problem of the optimal tax on an externalitygenerating good is contrasted with the case where the government also needs other, distortionary taxes in order to satisfy its revenue requirements. The main result is that the Pigovian principle holds in a modified form in the latter case as well. The problem of the distributional impact of taxation is also studied for the special case of individuals with identical preferences and a utilitarian social welfare function.
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