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.
All three effects - the direct gain from internalizing the pollution externality, the gain from reducing reliance on distorting taxes, and the loss from an excise tax on , say, electricity - are valid considerations. The double dividend question (do the welfare gains from a pollution tax exceed the benefits from abatement?) is harder to answer. Among other things, it depends on whether pollution abatement is a local or a global public good. In the case of a local tax to produce a global public good (e.g. greenhouse gas reduction), the excise tax on electricity is a source of local welfare loss and thus threatens the double dividend. The result of a local tax to produce a local public good is different. Because the direct gain from pollution control is a net benefit, workers would in the net be attracted to, not repelled from, the region that imposed the tax. In that case, the prospects for a double dividend are more promising.
Note that the double dividend question is an important consideration in the choice between pollution taxes and cap-and-trade schemes. Pollution taxes are more likely to generate double dividends. Nevertheless, cap-and-trade schemes seem more politically acceptable in many jurisdictions, presumably because polluting industries regard them as less onerous.
*Forthcoming from Edward Elgar Publishers
