| Abstract: | In their recently revised book Baumol and Oates (“The Theory of Environmental Policy,” 2nd ed., Cambridge Univ. Press, Cambridge, UK 1988) accept Bird's argument on the optimal taxation policy when externalities are shiftable and depletable. Their conclusion is that the standard Pigouvian tax which is placed upon the generator of a negative externality can be extended to tax the victims who shift the externality to others or extended to compensate recipients in order to achieve Pareto optimality. It is shown in this paper that their conclusion is not free from error, because the possibility of resisting a shifted externality and conjectural variations by recipients is not recognized. Whether an externality is shiftable depends not only on the shifting activity of the original victim but also the resisting activity of his neighbors and their conjectures about each other's action. As such, the shifters should be taxed and the recipients should be compensated at the same rate per unit of externality shifted if the tax base is the output of the shifting and resisting activities. On the other hand, if the tax base is the input which produced the shifting of the externality, then both the shifters and the recipients should be subject to a tax (or subsidy) per unit of input that they have engaged in. Whether it is a tax or a subsidy depends on the direction and magnitude of the conjectural variation. The model and its policy implication can be generalized to cover the omnipresent and wasteful rent seeking activities. |
