Atmospheric Externalities and Environmental Taxation

The paper reviews the theory of environmental taxation under first best and second best conditions. It argues that negative environmental externalities lead to reductions of the provision of public goods, while investment in abatement increases the supply of public goods. Together with optimal tax rules, the paper therefore also derives conditions for the optimal use of resources on abatement. After brief discussions of the dimensions of time and uncertainty, tax reform and the double dividend, and taxes versus quotas, the optimal tax model is applied to the problem of global warming with a discussion of the particular incentive problems that arise in designing and implementing global climate policy.