Green Tax Reform and Competitiveness

This paper develops a model of a small open economy that produces an export good with domestic labour and imported energy and is stuck in an unemployment situation resulting from an excessive fixed net-of-tax wage rate. We study a revenue-neutral green tax reform that substitutes energy for wage taxes. A moderate green tax reform will boost employment, improve welfare, and increase the economy's competitiveness. The driving force behind these results is the technological substitution process that a green tax reform will bring about by inducing the producers to substitute labour for energy as factors of production. The resulting reduction in unemployment is welfare increasing since energy, which the country has to buy at its true national opportunity cost, is replaced with labour, whose price is above its social opportunity cost. As long as the labour tax rate exceeds the resource tax rate, a revenue-neutral green-tax reform will reduce the domestic firms' unit cost of production and hence increase international competitiveness and output of the economy.

Evaluating Tax Reforms in the Presence of Externalities.

According to the double-dividend hypothesis, revenue-neutral green tax reforms are expected both to improve the quality of the environment and to reduce the existing tax distortions. This paper develops welfare measures which are used to estimate these dividends separately. It is shown that the existing tax system and the choice of the tax rate cuts which accompany an increase in green taxes have considerable impact on the magnitude of the environmental dividend. Even a negative impact cannot be ruled out. Furthermore, the welfare measures allow the authors to analyze the trade-off between the two dividends and to identify welfare-improving tax reforms. Copyright 1996 by Royal Economic Society.