Health effects and optimal environmental taxes in welfare state countries.

Most studies on the green tax reform issue point out that environmental taxes exacerbate pre-existing tax distortions, thereby increasing the welfare costs associated with the overall tax code. As a result, the optimal environmental tax should lie below the Pigovian level (or marginal social damages). This article challenges this finding by arguing that health benefits from reduced pollution may sufficiently affect labor supply to create benefit-side tax interactions which, in turn, may be of the same magnitude as cost-side ones. Using a simple general equilibrium model that assumes the existence of a social security system, this paper shows that the optimal environmental tax rate could be greater than traditionally thought.