A DISTRIBUTIONAL ANALYSIS OF AN ENVIRONMENTAL TAX SHIFT: Introduction 3

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The debate over a green tax shift and the Double Dividend Hypothesis has focused on efficiency considerations. In addition, distributional considerations are clearly important and little work has been done in this area. These concerns are relevant given the sense that most energy and environmental taxes are regressive. While some authors have challenged this perception by taking into account lifetime considerations (e.g. Bull, Hassett, and Metcalf (1994)), it is clear that distributional concerns limit political support for the greater use of environmental taxes.

Previous discussion of the distributional problem suffers by looking at the environmental taxes in isolation. While it might be the case that the imposition of an environmental tax by itself is regressive, it is quite possible that a revenue neutral tax reform where an environmental tax replaces some other tax could be progressive. A recent study by Hamond et al. (1997) emphasizes this point. Below, I will consider reforms (based on suggestions in Hamond et al.) that are designed to maintain or perhaps increase the progressivity of the tax system. I will also compare the distributional impact of an environmental tax reform to a reform that shifts from income to consumption taxation, a topic of some current policy interest.

Methodology A. Incidence Assumptions An incidence analysis attempts to answer the question who bears the burden of a particular tax. Any attempt to evaluate the “fairness” of a tax (or a change in the tax system) requires knowing whose disposable income is changed and by how much in response to the tax.
Economists often refer to taxes as “regressive” or “progressive.” There is often some confusion as to the meaning of these terms and so it is worth defining them carefully. The definition that most economists use relies on the average tax rate – the ratio of tax liabilities to income. A tax is said to be regressive if the average tax rate falls with income. It is proportional if the average tax rate is constant and it is progressive if the average tax rate rises with income. Low income people pay a higher (lower) fraction of their income in taxes if the tax is regressive (progressive).
Early tax incidence studies used the results of partial or general equilibrium models to inform judgments about relevant incidence results. In effect, these studies used existing research results to generate plausible assumptions about the incidence of specific taxes. Pechman (1985) represents the classic example of this type of research.