Environmental Taxation, Employment and Public Spending in Developing Countries

This paper investigates the consequences of environmental tax reforms for unemployment and welfare, in the case of developing countries with a large informal sector, rural–urban migration, and three different assumptions about public spending: (1) as part of a revenue-neutral policy, (2) fixed, and (3) varying endogenously. Under the indexation of unemployment benefits and informal-sector income that give rise to a double dividend, a lower level of public spending is associated with a smaller negative impact on the after-tax income of households and a higher increase in employment. These policies, however, still lead to a reduction in social welfare; even more so in the case of endogenous public spending, although it is associated with a higher increase in employment and a smaller reduction in private-sector incomes. The model implies that complementary policy, in terms of lower public spending, is unlikely to be socially acceptable, and does not support the case for a green tax reforms in developing countries.