Optimal differentiation of international environmental taxes in the presence of national labor market distortions

We explore the implication of the 'double dividend' debate for internationa l environmental taxes. In our scenario, small open economies with different labor market distortions follow a common environmental policy and use nati onal environmental tax revenues to finance labor tax cuts. Since the double dividend hypothesis does not hold, a high labor tax implies a low environm ental tax relative to other countries. The optimal differentiation of inter national environmental taxes is proven to be a function of the national lab or tax rates and the uncompensated elasticities of labor supply.