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The financial crisis and fiscal consolidation in green budgets

image of The financial crisis and fiscal consolidation in green budgets

This project adds insight into the potential contribution to fiscal consolidation from environmental tax and subsidy reforms, i.e. strengthening public budgets while at the same time improving economic efficiency and the environment. The report contributes with own calculations for potential revenues from environmental taxes and discusses the financial crisis and environmental tax policy responses in Iceland, Estonia and Ireland as case studies. The analysis has been carried out during the period July 2012 – December 2012 by Vista Analysis AS, Norway, Reykjavik University, Iceland and PRAXIS Center for Policy Studies, Estonia. The project was commissioned by the Nordic Council of Ministers.

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Appendix

The purpose of environmental taxes (Pigouvian taxes) is to internalize environmental externalities into markets (Pigou 1920, Sandmo 1975). According to economic theory, an optimal environmental tax should be levied directly at the externality and equal the marginal damage cost of the pollution.23 The optimal use of environmental taxes is illustrated in Figure 14. In the general case, marginal damage costs (MDC) increase with increasing emissions, while marginal abatement costs (MAC) increase with higher abatement, i.e. decreasing emissions. The optimal emission level, minimizing the total abatement costs, occurs when marginal damage costs equal marginal abatement costs. This is when the tax, t, is set optimal, t*=MDC=MAC. If MDC is constant, t*=MDC. This is relevant when the regulation is not likely to influence marginal damage costs, e.g. local/national greenhouse gas emissions instruments.

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