Alan Randall, preeminent environmental economist (and my Department Chair--yep I'm sucking up), is in the process of putting together a 3rd edition of his popular graduate text, Resource Economics*--this time co-authored with John Bergstrom. In response to a hallway conversation over Mankiw's double-dividend argument in favor of a carbon tax over cap and trade, Alan sent me this excerpt from the third edition:
A double dividend? Even if a pollution tax and a quantity control (a standard, or tradable permits) were otherwise equivalent, we might perhaps prefer the tax for fiscal reasons. Specifically, because government must raise revenues and most revenue-raising mechanisms distort economic incentives, a pollution tax might be argued to do not one but two good things: help clean-up the environment and reduce government reliance on distorting taxes. However, economists have argued that this "double dividend" is, at least in part, a matter of wishful thinking. The argument is that, yes, a pollution tax would restore efficiency in the polluting sector and reduce emissions, and reduce reliance on distorting taxes, but it would also introduce an inefficient excise tax on the commodity produced in the polluting process (say, electricity). Excise taxes, too, are distorting, and it has been argued that workers facing such a tax would demand higher wages, imposing additional costs on the economy.