Environmental Controls, Scarcity Rents, and Pre-Existing Distortions

Abstract

The debate in the literature 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 revenue-raising and non-revenue-raising policies can achieve equivalent welfare-raising effects of environmental protection without exacerbating the labor distortion. These favorable effects can be achieved by taxes that raise revenue, certain command and control regulations that raise no revenue, and even subsidies that cost revenue. Instead, the exacerbation of the pre-existing labor tax distortion is associated with policies that generate privately-retained scarcity rents. These rents raise costs 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.