On green production taxes

Proposals are often made to tax goods which are environmentally damaging. Many such goods are consumed both directly by households and industry at large: for example, carbon-intensive fuel, waste water or congested road space. This paper adopts a tax-reform setting to evaluate such a policy. The welfare impact is shown to depend on an input-substitution effect and an output effect on final consumption, where the latter effect can be conveniently analysed via the standard concept of the marginal welfare cost of a commodity tax. Finally, it is shown that raising a production tax is welfare enhancing if the current tax is below marginal external cost and revenues are recycled via the commodity tax with the highest marginal welfare cost.externality taxes, productive efficiency, tax reform