POLITICAL INTERNALIZATION OF ECONOMIC EXTERNALITIES AND ENVIRONMENTAL-POLICY

This paper derives the characteristics of endogenous environmental pol icy in a common agency model of politics, and proceeds to show that co mpetition between lobby groups is an important source of internalizati on of economic externalities. Our analysis generalizes Bhagwati's prin ciple of targeting to the case of distorted political markets. Moreove r, we show that the politically optimal structure of environmental tax es incorporates a Pigouvian adjustment. However, since lobby groups ca re about the distribution of income as well as about efficiency, the e quilibrium structure of taxes differs considerably from the Pigouvian rule. (C) 1998 Elsevier Science S.A.