Green Tax Reform in Sweden: The Second Dividend and the Cost of Tax Exemptions

This study assesses the cost of achieving pollution reductions using environmental taxes relative to using non-revenue-raising instruments. The cost of tax exemptions with or without employment constraints is also examined. Using a computable general equilibrium model of the Swedish economy a wide range of emission reduction target levels are examined. The study finds that the reduction of CO2 emissions between 5 and 25 percent could be achieved at a cost up to 9 percent lower if taxes are used instead of (non-revenue raising) quantity regulations. Also, the removal of tax exemptions on certain industries could substantially lower the cost, even with employment constraints on these sectors. However, removing exemptions will have effect on other emissions such as SO2 and NOx. A tax structure similar to the one that arises from the use of tax exemptions could be motivated by additional emission reduction goals for these pollutants. Using monetary estimates for SO2, NOx and CO2 emission damages, the results indicate that a unilateral CO2 tax increase could yield a welfare improvement if valuation of CO2 emission reduction exceed 0.3 SEK per kg. ∗ This study has been carried out as part of the project “Green Taxes: Environment, Employment and Growth” (ENV4-CT96-0231). Financial support from the European Union is gratefully acknowledged. The author is grateful to Lars Bergman, Ing-Marie Gren and Charlotte Nilsson for helpful comments and suggestions. ∗∗ Address: Department of Economics, Stockholm School of Economics, Box 6501, SE-113 83 Stockholm, Sweden. Email: [email protected].