Trade, environment, and income inequality: An optimal taxation approach

Abstract

In a small open economy, how should a government pursuing both environmental and redistributive objectives design domestic taxes when redistribution is costly? And how does trade liberalization affect the economy's levels of pollution and inequalities, when taxes are optimally and endogenously adjusted? Using a general equilibrium model under asymmetric information with two goods, two factors (skilled and unskilled labor) and pollution, this paper characterizes the optimal mixed tax system (nonlinear income tax and linear commodity and production taxes/subsidies) with both production and consumption externalities. While optimal income taxes are not directly affected by environmental externalities, conditions are derived under which under-or over-internalization of social marginal damage is optimal for redistributive considerations. Assuming that redistribution operates in favor of the unskilled workers and that the dirty sector is intensive in unskilled labor, simulations suggest that trade liberalization involves a clear trade-off between the reduction of inequalities and the control of pollution when the source of externality is only production; this is not necessarily true with a consumption externality. Finally, an increase in the willingness to redistribute income towards the unskilled results paradoxically in less pollution and more income inequalities.JEL: H21, H23, F13, F18

The Impact of Foreign Trade on Health Inequality in China: Evidence From China Family Panel Studies (CFPS)

“…Environmental pollution can accelerate the depreciation of individual health [31,32]. The rich's willingness and ability to pay for a clean environment are higher while the poor are always exposed to areas with a high concentration of pollution, indicating that environmental inequalities could lead to health inequalities [33][34][35][36]. The effect of foreign trade on environmental pollution depends on the net effect of scale effect, structure effect, and technology effect.…”

“…Structure effect is ambiguous depending on whether international trade transfers green industrial structure [37][38][39][40]. The differences in these three effects of foreign trade among provinces can contribute to environmental inequalities [35,41,42]. Richardson et al (2013) [34] found that the free trade between eastern and western counties deteriorated the environment in less-developed western counties, leading to Europe-wide mortality inequalities.…”

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“…However, the distributional effect of public R&D investment has received little attention. In the extant literature, the focus is more on public education (e.g., Benabou, ; Glomm & Ravikumar, ), globalization (e.g., Bontems & Gozlan, ) and infrastructure and taxes (e.g., Alesina & Rodrik, ; Chatterjee & Turnovsky, ; Garcia‐Penalosa & Turnovsky, ; Getachew, ; Getachew & Turnovsky, ). R&D investment could have uneven impacts on the economy and, through this channel, could impact rich and poor differently.…”

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“…They show that depending on the marginal disutility of pollution, the regions will compete by either undercutting or increasing their tax rates. In a small open economy setting, Bontems and Gozlan () analyze the trade‐off between environmental and redistributive goals within an optimal taxation model. They derive conditions under which it is optimal to either underinternalize or overinternalize social marginal damage for redistributive considerations.…”