When consumers or firms don't face the true social cost of their actions, market outcomes are inefficient. In the case of negative externalities, Pigouvian taxes are one way to correct this market failure, but it may be infeasible to tax the externality directly. The alternative, taxing a related product, will be second-best. In this paper, we show that in the presence of heterogeneous externalities and elasticities, this type of indirect tax performs poorly. In our empirical application, gasoline taxes to address pollution externalities, less than a third of the deadweight loss of the externality is addressed by second-best optimal taxes.
"The Welfare Impact of Second-Best Uniform-Pigouvian Taxation: Evidence from Transportation."
American Economic Journal: Economic Policy,
Taxation and Subsidies: Efficiency; Optimal Taxation
Taxation and Subsidies: Externalities; Redistributive Effects; Environmental Taxes and Subsidies
State and Local Taxation, Subsidies, and Revenue
State and Local Government: Other Expenditure Categories
Air Pollution; Water Pollution; Noise; Hazardous Waste; Solid Waste; Recycling
Transportation Economics: Government Pricing and Policy