| Global warming is the potential climate change that may result from atmospheric changes caused by economic activity. It is an externality because the costs are not fully considered by agents making the decisions that cause climate change, but are borne by future generations. Individuals have little incentive to change their behavior, even if they care about avoiding future damages, because individual actions have negligible effect. If society cares about the future it must take collective action.;The threat of global externalities has stimulated renewed interest in the efficiency of Pigovian taxes as a control mechanism. These taxes would be imposed in a second-best world with other distortionary taxes already in place. The possibility of a double dividend exists if Pigovian taxes mitigate the externality and the revenues can be recycled to reduce existing distortionary taxes. However, recent studies suggest that adding narrowly-based Pigovian taxes may exacerbate the total distortions, reducing economic efficiency. We investigate these issues in overlapping generations models of an economy in which energy use causes environmental damage (global warming) that enters the production function over time. The government faces an exogenously-determined revenue requirement which it meets through taxes. In one version of the model labor is supplied inelastically and the government's revenue alternatives are (nondistorting) consumption taxes and energy taxes. In the second version, leisure enters the utility function and the government uses income and energy taxes. Our results show that in this economy the introduction of the energy tax is welfare improving when environmental benefits are considered. We also demonstrate that the optimal level of the energy tax is above the Pigovian level if revenue requirements are high enough to necessitate positive levels of a distorting tax. This result holds even if there is no environmental externality. |
