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This paper analyzes the optimal urban congestion toll in a second-best setting where only one road in a network can be tolled. Both heterogeneity in labor productivity and income distribution concerns are considered. The optimal toll balances two types of considerations. The first consideration is the correction of the congestion externality on the tolled road given the distortion on the non-tolled roads, while the second is the equity consideration that takes into account which income group uses the tolled road and how toll revenues are spent. Both separating and pooling equilibria are analyzed for two alternative uses of toll revenues: poll transfers and labor-tax cuts. Using numerical simulations, we show that equity concerns can lead a government to prefer inefficient toll levels and recycling via poll transfers rather than via labor tax reductions.

The introduction of the European Community's carbon-energy tax in a small open economy is analyzed by comparing two kinds of revenue recycling. We use a dynamic general-equilibrium model with different regimes for the labor market, several income groups, and a crude valuation of environmental benefits. This allows for a more comprehensive empirical test of the double-dividend hypothesis, including equity aspects. It is shown that the weak double-dividend hypothesis can fail when equity aspects are taken into account.