Postprint version. Published in International Tax and Public Finance, Volume 17, Issue 6, December 1, 2010, pages 607-626.
The definitive version is available at https://doi.org/10.1007/s10797-010-9130-3.
This paper investigates the exploitation of environmental resources in a growing economy within a second-best fiscal policy framework. Agents derive utility from two types of consumption goods — one which relies on an environmental input and one which does not — as well as from leisure and from environmental amenity values. Property rights for the environmental resource are potentially incomplete. We connect second best policy to essential components of utility by considering the elasticity of substitution among each of the four utility arguments. The results illustrate potentially important relationships between environmental amenity values and leisure. When amenity values are complementary with leisure, for instance when environmental amenities are used for recreation, optimal taxes on dirty goods generally increase over time. On the other hand, optimal taxes on dirty goods generally decrease over time when leisure and environmental amenity values are substitutes. Under some parameterizations, complex dynamics leading to non-monotonic time paths can emerge.