Optimal taxation with dual atmospheric-consumption externalities

This paper generalizes optimal taxation results to study goods that yield both atmospheric and consumption externalities, where the number of users affects the benefits of consuming the good. Commodity taxes therefore affect utility through both price effects and by affecting the number of users. We evaluate the importance of these consumption externalities to optimal tax policy in a dynamic setting using Monte Carlo simulations. Time-varying tax schedules can improve total surplus and increase total tax revenues, compared to a time-invariant sequence. This stands in contrast to a strand of the public finance literature de-emphasizing commodity taxation as a means for efficiently raising revenue. The authors are grateful for comments and suggestions from Don Bruce, Naomi Feldman, Jim Hines, David Madden, Matt Murray, Bill Nielson, Charles Sims, and conference and seminar participants at the IIPF Annual Congress and Ume̊a University. Hargaden, corresponding author, email: enda@utk.edu. Harris email: mharris@utk.edu.