A Note on Externalities and Taxation.

Abstract

The purpose of this paper is to explore the distributional aspects of a tax that is imposed in order to correct the detrimental effects of a production externality. In the general framework of a two-sector general equilibrium model, the author shows that A. B. Harberger's classic results of tax incidence may change considerably because of the presence of the externality. The author also shows that the tax is effective in reducing the detrimental effect of the externality, although the return of the taxed.factor may rise relative to the return of the untaxed factors.