Optimal fiscal policy with environmental tax and pollution abatement spending in a model with utility-enhancing environmental quality: lessons from Bulgaria

ABSTRACT

This paper characterized optimal fiscal policy in the presence of pollution, and evaluated it relative to the observed one in Bulgaria. To this end, a dynamic general-equilibrium model is calibrated to Bulgarian data. The main findings are: (i) The optimal steady-state income tax rate is zero; (ii) the benevolent Ramsey planner provides 20% higher utility-enhancing environmental quality; (iii) the optimal level of carbon taxes is almost three times higher, and the optimal level of abatement spending is six times higher; (iv) the optimal steady-state consumption tax is twice lower.

KEYWORDS:

• Ramsey policy
• pollution
• environmental quality
• environmental tax

JEL CLASSIFICATION:

• C68
• Q2
• Q4
• Q54
• Q58

Disclosure statement

No potential conflict of interest was reported by the author.

Notes

1. For, example, Chari and Kehoe (1994, 1999), and many others.

2. From the government constraint it is clear that carbon taxes are an additional burden on labour and capital income.

3. Note that when the household and the firm are making optimal choices, they are taking all fiscal policy variables as given. Also note that the benevolent government treats everyone the same, i.e. we have already imposed the symmetry in the constraints.

4. Note that the government transfers will be held fixed at the level computed from the equilibrium under the exogenous policy case.

5. In case the government is allowed to use lump-sum taxation, it can achieve the first-best (Pareto) allocation.

6. Note that $r_t,w_t$ were functions of ${\tau }_t^E$.

7. Note that by choosing capital, hours and abatement spending, the Ramsey planner chooses environmental quality optimally as well.

8. IRFs under both regimes identical, focus on steady-state/long-run allocations, analytical results.

Additional information

Notes on contributors

Aleksandar Vasilev

Aleksandar Vasilev is currently a Lecturer at the Lincoln International Business School, University of Lincoln, UK. He received his PhD in Economics (specialization in Macroeconomics) from the Adam Smith School of Economics, University of Glasgow, UK in 2013. His research interests include Quantitative Macroeconomics, Fiscal Policy, and Labor issues. He has published articles in such journals as the Journal of Public Economic Theory, Bulletin of Economic Research, Review of Economics and Institutions, the European Journal of Comparative Economics, and LABOUR.