Income Tax, Commodity Tax and Environmental Policy

Using the self-selection approach to tax analysis, the paper analyses the impact of environmental externalities on Pareto-efficient non-linear income tax, proportional commodity taxes and public expenditure. Consideration of externalities within this framework reveals intuitive insights into environmental tax policy, suggesting that some earlier conclusions drawn in the relevant literature might be misleading. The results indicate that, while the externality's direct harmful impact raises marginal tax rates, the influence through the self-selection constraint tends to decrease the rise. We also derive conditions under which the Pigovian tax can be determined purely on the basis of internalizing the externality.