Policy analysis in the presence of distorting taxes

Abstract

This article first describes the new literature in environmental economics on the so-called “double-dividend” and then explores its implications for a broad range of economic issues. This literature reveals that in a second-best, general-equilibrium setting, environmental measures raise costs and prices and thereby reduce the real wage. This rise in the cost of living reduces slightly the quantity of labor supplied in an already highly distorted labor market, giving rise to losses in social welfare that can be large relative to the basic gains from a cleaner environment. These losses can be offset to some extent by using revenues (if any) from the environmental programs to reduce existing taxes on labor. This same line of analysis applies to many programs and institutions in the economy that raise the cost of living: tariffs and quotas on imports, agricultural price-support programs, monopoly pricing, programs of occupational licensure that limit entry, and many others. Thus, traditional, partial-equilibrium benefit-cost analysis appears, in many instances, to have unwittingly omitted from the calculations a potentially quite significant class of social costs. © 2000 by the Association for Public Policy and Management.