I then compare these reforms to a reform that shifts the tax base from income to consumption. In this case, it is difficult to maintain the level of progressivity that exists under the current income tax although ways exist by which the regressivity of the reform could be blunted. Whether the long term growth gains from consumption tax reform would offset the initial increase in regressivity remains to be determined. In addition to a wholesale replacement of the income tax with a consumption tax, I also consider a partial shift.
In sum, distributional concerns need not stand in the way of the increased use of environmental taxes. Whether welfare is improved overall by such reforms is a question beyond the scope of this paper but the results shown below suggest the value of continuing to study these reforms and to begin consideration of their adoption.
The next section provides some background on the issue of environmental (or green) tax reforms. Next, I describe how I measure the distributional impact of tax reforms and describe the data. Section IV provides results from the analysis and a concluding section follows.
Background on Green Tax Reforms There has been a great deal of interest in recent years in the use of environmental tax revenues to substitute for some portion of existing tax collections. The issue of a substitution of environmental for other taxes can be traced back to Tullock (1967) and more recently Terkla (1984). This early literature focused on the efficiency implications of an environmental reform and led to a debate over what has been dubbed the “Double Dividend Hypothesis.” One strand of this literature (as typified by Terkla) considers a reform in which environmental regulations are replaced with tax instruments in such a fashion that pollution activities are unaffected. But the switch from a regulatory to a taxation mechanism for limiting pollution raises revenue that can be used to lower other distorting taxes. This shift has unambiguous welfare gains. Another strand of the literature (typified by Pearce (1991) and Repetto (1992)) focuses on the use of environmental taxes both to reduce pollution and to raise revenue to lower other taxes. While it is clear (see Bovenberg and deMooij (1994) as well as Parry (1995)) that there are also efficiency costs with environmental taxes (separate from the environmental benefits), it is also clear that efficiency improvements are possible if tax reforms are designed carefully.