A DISTRIBUTIONAL ANALYSIS OF AN ENVIRONMENTAL TAX SHIFT: Introduction 7

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Finally, taxes on products are passed forward to consumers in the form of higher product prices and taxes on intermediate inputs flow through to consumers in the form of higher consumer prices. This assumption is valid for industries composed of identical firms with free entry and exit in which the supply of factors is perfectly elastic. In this case, factor prices are fixed and the supply of consumer goods is perfectly elastic. Other incidence assumptions would lead to different results. For example, to the extent that consumers reduce their energy consumption in response to the carbon and gas taxes, the incidence could be shifted back to the factors of production in energy industries in the form of lower wages for workers in energy industries, lower returns for owners of capital in this sector, or lower rents to owners of energy resources. This would occur if factor supplies are not perfectly elastic in the area around the original equilibrium. Clearly the ultimate incidence effects could differ markedly if the tax is passed backwards rather than forwards.

The analysis that I undertake in this paper measures the burden of taxes under the assumption that substitution in production or consumption in response to price changes does not occur. Thus, this should be viewed as a first order incidence analysis. Clearly, one of the goals of the reform is to raise the price of pollution and consequently reduce polluting activities. To the extent that that is successful, tax collections will fall and either environmental tax rates will have to be increased, or other tax rates will have to rise to keep revenue collections constant. This suggests a “problem” for environmental taxes as revenue raising instruments. To the extent that they are successful in reducing pollution, they will not raise the hoped for revenue. Note though that while tax collections may fall, product prices are still likely to rise as firms engage in costly activities to avoid the use of taxed polluting inputs. Thus, even if pollution drops significantly as a result of a Green tax reform, the incidence results described here may not be substantially changed.