The Double Dividend and Other Applications of “Normalization”as a Benchmark for
Environmental Policy
Yoram Bauman
June4,2004
Address after August1,2004:
Dept.of Economics
Whitman College
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Walla Walla WA99362
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The Double Dividend and Other Applications of “Normalization”as a Benchmark for
Environmental Policy
Abstract
Although the ultimate goal of environmental policy is to improve social welfare,a useful benchmark is the“normalization”of environ-mental ,policies that result in parity between environmen-tal goods and“normal”goods.This paper applies the normalization benchmark to the areas of the double dividend hypothesis,asymmet-ric information,dynamic optimality,and regulation of monopoly. One result is a more appropriate description of the contentious dou-ble dividend hypothesis.This description,which supports the origi-nal claims of double dividend proponents,compares a world with an environmental good with an otherwise identical world containing a similar but“normal”good.
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The distinguishing feature of environmental goods is the divergence of private marginal costs from social marginal costs.For any environmental good e,then, one can imagine a sister good n that has the same social marginal cost structure as e but a“normal”private marginal cost ,one in which private marginal cost equals social marginal cost.
Thought experiments involving e and n provide insight into a number of issues in environmental economics,including the double dividend hypothesis, asymmetric information,and dynamic optimality.In addition to shedding light on each of these three issues,this paper also hopes to make a larger point about the value of normalization—i.e.,inducingfirms and other relevant agents to treat e as they would treat n—as a benchmark for environmental policy.
1The Double Dividend
Imagine sister worlds E and N,identical except that the“environmental”world E contains the environmental good e and the“normal”world N contains the normal good n.
Given that e and n have the same social marginal cost structure and that the worlds are otherwise identical,it is obvious that both worlds can achieve the same level of social welfare under ideal circumstances.Formally,this yields Proposition1Thefirst-best outcome in worlds E and N are identical.
Now imagine that circumstances are less than ideal,in that there is an (exogenously specified)need for government revenue and an inability to levy
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lump-sum taxes.How do the second-best outcomes in the two worlds match up?
One might think that a social planner in the environmental world would be lucky to reach the same level of social welfare as that attainable in its sister world.But what if the social planner in the environmental world can reach a higher level of social welfare than that achievable in the normal world?In this case one might argue that the presence of the environmental good e is(at least potentially)a blessing in disguise.One might further argue that,when combined with the appropriate(second-best)policies,the presence of the environmental good yields a“double dividend”:the social planner in the environmental world can not only match the level of social welfare in the normal world(thefirst dividend),but actually surpass it(the second dividend).
A simple representative agent model shows how this double dividend can ap-pear.Consider the second-best outcome in the normal world,which is achievable through some tax vector t.The market price vector p can then be written as p=m+t,where m is the price excluding the tax.In particular,for the sister good n we have p n=m n+t n.(Note that in equilibrium m n is the private—and the social—marginal cost of production.)
Next consider the environmental world E.For simplicity,assume that the private marginal cost of produc
ing good e is zero.Now imagine setting the tax on good e equal to t e=m n+t n,and the taxes on all other goods equal to those in world N.Further imagine instituting a lump sum transfer of m n·q n to the representative agent,where q n is the amount of good n purchased in equilibrium
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in the normal world.This leads to
Proposition2Social welfare in the environmental world can match the second-best level of social welfare in the normal world.
Proof.The policy described above effectively eliminates the differences between the two worlds by equalizing the market price vectors and the representative agent’s income in the two worlds.1The policy also equalizes government tax receipts in the two worlds:the additional taxes in the environmental world are exactly offset by the additional transfers.It follows that social welfare in the two worlds will be equal.
This shows that the social planner in the environmental world can reach the same level of social welfare as the social planner in the normal world.But clearly she can do even better than that:instead o
f providing lump-sum transfers,the social planner could reduce distortionary taxes.(This is nothing more than the “weak double dividend”hypothesis as formulated by Goulder1995.)Combined with the previous proposition,the result is
Proposition3Social welfare in the environmental world can exceed the second-best level of social welfare in the normal world.
This result does not“prove”that the double dividend hypothesis is correct, 1Note that the additional tax collection of m n·q n in the environmental world is a surrogate for the private payment of that amount in the normal world,and also that the lump sum transfer of m n·q n in the environmental world is a surrogate for the private receipt of that amount in the normal world.
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