DP869 | Does a Tougher Environmental Policy Raise Unemployment? Optimal Taxation, Public Goods and Environmental Policy With Rationing of Labour Supply

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The implications of more environmental concern for the optimal provision of public goods, taxation, environmental policy and involuntary unemployment are derived within a second-best framework in which lump-sum taxes and subsidies are not available and labour supply is rationed due to a rigid consumer wage. In the absence of factor substitution more environmental concern raises involuntary unemployment. The shift from distortionary to non-distortionary taxation depresses the marginal cost of public funds, thereby creating more room for public spending. Nevertheless, public consumption may fall in order to make room for public abatement if the productivity of the latter tapers off slowly and if the profit tax rate is low. With factor substitution between labour and polluting resources, a shift towards greener preferences boosts employment if labour is a better substitute for polluting resources than the fixed factor, the profit tax is low, and the production share of the fixed factor is large. If initial environmental concern is small, public consumption may rise as well.