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Free-Riding on Environmental Taxation

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  • Maria Chistyakova
  • Philippe Mahenc

Abstract

We examine how tax avoidance affects the optimal design of a linear tax on polluting emissions in a monopoly setting. The firm is owned by shareholder who differ in their cost of tax dodging. Following Buchanan (1969), the optimal tax should correct for two negative externalities due to pollution and the monopolist's behavior. The analysis highlights two conflicting effects of tax avoidance on the environmental policy design: a free-riding effect and a tax base erosion effect. With heterogeneous tax avoidance, the regulator must also internalize the externality imposed by the free-riding of tax avoiders on the rest of the society. This free-riding makes the regulator either impotent or unfair, depending on the severity of the environmental damage and the firms' efficiency. We also show that a two-part tax schedule can achieve the first-best outcome.

Suggested Citation

  • Maria Chistyakova & Philippe Mahenc, 2015. "Free-Riding on Environmental Taxation," CEEES Paper Series CE3S-02/15, European University at St. Petersburg, Department of Economics.
    • Handle: RePEc:eus:ce3swp:0215
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    References listed on IDEAS

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    More about this item

    Keywords

    environmental taxation; monopoly; tax avoidance;
    All these keywords.

    JEL classification:

    • D43 - Microeconomics - - Market Structure, Pricing, and Design - - - Oligopoly and Other Forms of Market Imperfection
    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
    • H23 - Public Economics - - Taxation, Subsidies, and Revenue - - - Externalities; Redistributive Effects; Environmental Taxes and Subsidies
    • L12 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance - - - Monopoly; Monopolization Strategies
    • Q28 - Agricultural and Natural Resource Economics; Environmental and Ecological Economics - - Renewable Resources and Conservation - - - Government Policy

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