Marginal tax reform, externalities and income distribution

The paper examines welfare improving revenue neutral marginal policy reform s for an economy with non-identical individuals and an externality with a f eedback on the consumption of taxed commodities. The instruments considered are: indirect taxes, the uniform poll transfer and public abatement. This extends the framework of Ahmad and Stern [Journal of Public Economics, 25 ( 1984) 259-298], Bovenberg and de Mooij [American Economic Review, 84 (1994) 1085-1089] and Schob [Oxford Economic Papers 48 (1996) 537-555]. The theor y is illustrated for congestion caused by peak car transport. The desirabil ity of a higher externality tax is shown to depend on: the efficiency effec t of the revenue recycling, the externality benefit, the distributional cha racteristic of the commodities and the externality and the feedback effect. (C) 2001 Elsevier Science B.V. All rights reserved.