Double dividend hypothesis: Can it be validated by carbon taxation swap with payroll taxes?

Abstract

This paper is concerned with the proficiency assessment of the environmental tax reform to tackle the pollution and simultaneously decrease the tax burden of pre-existent labor taxation. In comparison with mainstream literature, we focus exclusively on the reduction of the tax distortions that affect labor demand, using the revenues generated by environmental levies. Our starting point is the double dividend hypothesis with respect to the environmental taxation. The main objective of this paper is to validate the second dividend hypothesis, hence testing the carbon taxation ability to reduce harmful effects of taxes on inputs such as labor. Following the trajectory of the double dividend hypothesis, the paper examines the potential of carbon taxation enactment accompanied by the payroll tax cuts in order to lower the efficiency costs of these pre-existent distortionary taxes. The feasibility of tax swap mechanism between environmental and payroll taxation is verified through estimating and comparing their efficiency costs. The results obtained from empirical analysis confirm that there is a high potential of swapping these taxes and implementing offsetting measures, where the efficiency costs of payroll taxation are considerably larger than of environmental taxation. Hence, we conclude that there is “enough room” for this tax swap mechanism to take place which would have a two-folded outcome – environment protection improvement and decreasing the efficiency costs of the fiscal system. Given the fact that the efficiency costs of environmental taxes are considerably lower (both in absolute and percentage values), than payroll taxation in the EU, it is possible to apply payroll tax cuts and consequently increase the ratio of environmental taxation.

DOI: http://dx.doi.org/10.5755/j01.ee.26.1.8399