Tax Deductions, Environmental Policy, and the “Double Dividend” Hypothesis

Recent studies find that environmental tax swaps typically exacerbate the costs of the tax system and therefore do not produce a “double dividend.” We extend previous models by incorporating tax-favored consumption goods (e.g., housing, medical care). The efficiency gains from recycling environmental tax revenues are therefore larger because pre-existing income taxes distort both consumption decisions and factor markets. In this setting a revenue-neutral emissions tax (or auctioned permits) produces a double dividend. Moreover, the overall costs of environmental tax swaps are negative, for modest emissions reductions. The efficiency gains from emissions taxes over grandfathered permits are also much larger than previously recognized.