ENVIRONMENTAL TAXES AND QUOTAS IN THE PRESENCE OF DISTORTING TAXES INFACTOR MARKETS

Environmental quotas tend to compound the welfare cost of pre-existing tax distortions in the labor market. Under plausible parameters, this source of welfare loss can easily be large enough to outweigh the ent ire partial equilibrium welfare gain from the quota. Environmental tax es induce the same interaction effect, however they also raise governm ent revenues. If the revenues are used to reduce distortionary taxes, then most of this interaction effect can be offset. Therefore, revenue -raising can be a necessary condition for environmental policies to in crease welfare. (C) 1997 Elsevier Science B.V.