Conference Agenda

This paper builds and employs a new analytical general equilibrium model to find a closed-form solution for the second-best optimal (SBO) tax on a relatively “good” clean production or disposal method, and the SBO tax rate on a “bad” polluting production or disposal method, in the case where no tax can be imposed or enforced on the most polluting “ugly” production or disposal method (e.g., illegal dumping). This model can be applied to any environmental pollution problem, including disposal into the air, water, or land. We use intuition from Corlett and Hague (1953) to show that the tax on bad disposal might be lower than the tax on good disposal, if ugly disposal is enough better as a substitute for bad disposal than it is for good disposal. Our model captures not only differences in how the partial equilibrium cross-price elasticities help determine general equilibrium effects of each available disposal tax, but also how all own-price and cross-price elasticities and share parameters help determine those general equilibrium outcomes, including the amount of untaxed ugly disposal. And this general equilibrium change in each disposal amount is what matters for setting the two SBO tax rates. We also show how these elasticities combine with each disposal method’s marginal external damage parameter to determine the two SBO tax rates on good and bad disposal.