Conference Agenda

How should a government design a carbon tax when it is not only concerned by mitigating carbon emissions, but also income redistribution? This article extends a dynamic Mirrlees taxation model, typically used to characterize optimal labor wedges and savings wedges, to study the optimal commodity wedge between two goods, one of which is polluting. First, starting with the basic case where there are two non-polluting goods, I derive the optimal commodity wedge with non-separable preferences in a dynamic environment. Second, in the case where one of the goods is polluting and pollution damages both output and utility, I derive a modified optimal carbon tax whose output damages component remains Pigouvian and whose utility damages component is distorted by the labor wedge as well as the gap in complementarity in utility between each good and labor supply. The optimal carbon tax is fully Pigouvian if the labor wedge is zero, if both goods are equally complementary with labor, or if utility is separable. Moreover, the structure of both the labor wedge and the savings wedge is unaffected by the presence of pollution, suggesting that a properly designed commodity wedge is fully capable of internalizing the externality while respecting the social planner's redistributive goals.