The marginal efficiency effects of taxes and subsidies in the presence of externalities

Using 1983 data, we develop a 19-sector computational general equilibrium model, incorporating producer-producer externalities and producer-consumer externalities. Simulation results indicate that when additional government expenditure is financed by Pigouvian taxes, the marginal cost of public funds is substantially below one. Labor, sales, and output taxes also affect the output of the polluting industries, and thus have indirect Pigouvian effects which tend to reduce the associated marginal costs of public funds. Pigouvian taxes are usually more efficient than Pigouvian subsidies, since the tax revenue can be used to reduce other taxes.