ENVIRONMENTAL TAX-REFORM AND ENDOGENOUS GROWTH

This paper explores how an environmental tax reform impacts pollution, economic growth and welfare in an endogenous growth model with pre-ex isting tax distortions. We find that a shift in the tax mix away from output taxes towards pollution taxes may raise economic growth through two channels. The first channel is an environmental production extern ality, which determines the positive effect of lower aggregate polluti on on the productivity of capital. The second channel is a shift in th e tax burden away from the net return on investment towards profits. T he paper also shows that the optimal tax on pollution may exceed its P igovian level if tax-shifting towards profits is large and production externalities are important.