Accepted Manuscript Title: ENVIRONMENTAL TAXATION AND THE DOUBLE DIVIDEND HYPOTHESIS IN CGE MODELLING LITERATURE: A CRITICAL REVIEW Author: Jaume Freire-Gonzalez´ PII: S0161-8938(17)30120-5 DOI: https://doi.org/10.1016/j.jpolmod.2017.11.002 Reference: JPO 6397 To appear in: Journal of Policy Modeling Received date: 12-3-2017 Accepted date: 10-11-2017 Please cite this article as: & Freire-Gonzalez,´ Jaume., ENVIRONMENTAL TAXATION AND THE DOUBLE DIVIDEND HYPOTHESIS IN CGE MODELLING LITERATURE: A CRITICAL REVIEW.Journal of Policy Modeling https://doi.org/10.1016/j.jpolmod.2017.11.002 This is a PDF file of an unedited manuscript that has been accepted for publication. As a service to our customers we are providing this early version of the manuscript. The manuscript will undergo copyediting, typesetting, and review of the resulting proof before it is published in its final form. Please note that during the production process errors may be discovered which could affect the content, and all legal disclaimers that apply to the journal pertain. ENVIRONMENTAL TAXATION AND THE DOUBLE DIVIDEND HYPOTHESIS IN CGE MODELLING LITERATURE: A CRITICAL REVIEW Jaume Freire-González1,2 1 Department of Economics, Harvard University, Cambridge, Massachusetts 02138, United States. 2 ENT Environment and Management, Sant Joan, 39, 1, 08800 Vilanova i la Geltrú, Barcelona, Spain. Abstract Computable general equilibrium (CGE) modelling is a flexible and open way to model the economic systems that allow practitioners to assess the impacts of different policies or external shocks over an economic system. There is some empirical literature dedicated to test the double dividend hypothesis of an environmental tax reform using CGE models. This hypothesis claims that is possible to obtain an improvement of both environmental and economic conditions by imposing an environmental tax and recycling revenues obtained to reduce other pre-existing taxes. This research provides a comprehensive review of this literature including a statistical and a meta-regression analysis. 69 different simulations from 40 studies have been analyzed. 55% of simulations have achieved a double dividend, concluding that although the environmental dividend is almost always achieved, the economic dividend still remains an ambiguous question that needs further research. Keywords: Taxation; CGE; environmental policy; modelling; double dividend. JEL: C6, H2, Q5 1. CGE modelling and the double dividend hypothesis 1.1. Introduction Environmental taxation has been growingly seen as an effective economic instrument to create incentives in favor of cleaner production and consumption habits. Concerns about environmental problems like climate change, health or use of resources have fostered its useACCEPTED across different countries and regions onMANUSCRIPT several areas. Some authors highlight the advantages it represents over other economic instruments like payments for environmental services, tradable permit systems. There is an important discussion around the economic and environmental effects of this economic instrument. Conventional economic theory suggests that increasing the price 1 of normal goods and services through the use of a tax reduces its own demand. Pigou (1920) was the first to propose the use of taxes to internalize negative externalities. He showed that a direct tax on carbon emissions is the most efficient tax instrument for CO2 abatement. Empirical research has analyzed and corroborated this direct effect, however it is not clear the extension and dimension of the economy-wide effects. The affectation of an environmental tax on the overall economic system will ultimately depend on many factors, like its design and implementation, the economic structure on which it is implemented, consumer preferences or other socio-political factors. The price paid by a buyer and the one received by the seller is different if there is a tax. Given that, under some assumptions, prices coordinate efficient resource allocation, such difference reduces economic efficiency and consumer welfare by an amount greater than the revenue collected by the government. This is known in literature as the "deadweight loss" or "excess burden" of the tax system. Beyond the isolated effects of an environmental tax, there is a research and policy line that claims that an environmental tax reform (ETR) that increases the environmental taxes and, at the same time, reduces other taxes, keeping the same government revenue, generates a double benefit, by reducing negative environmental impacts and improving the economy.1 This is known as the ‘double dividend’ (DD) hypothesis, and it has been of growing interest amongst CGE modelers during the last years. However, there are different variations and interpretations of this hypothesis (Mooij, 1999). The main problem in the determination of the economy-wide effects of environmental taxation or other policies is the high complexity involved in modern economic systems and societies. There is a discussion among economists around the different existing theories and derivate methods used to assess these global effects. From more traditional economic perspectives, some modelling applied methods have been developed in order for account for overall economy-wide effects of policies or other external shocks. The most important ones are: macroeconometric models, input-output methods and applied general equilibrium methods. However, they are often interrelated in more complex assessments. Computable general equilibrium (CGE) methods and models are the most comprehensive way to take into account the most relevant aspects of an economic system (Dixon and Jorgenson, 2012). The great development of computing and IT technologies during the last half century have fostered their general use and an increasing its complexity. This complexity sometimes makes them difficult to understandACCEPTED for non-specialized audiences orMANUSCRIPT policy-makers, but also allow them to explicitly take into account more aspects of the economic reality than other methodologies. On the other side, these methods sometimes rely on controversial 1 Some countries that have already implemented different versions of explicit environmental tax reforms are: Sweden, Denmark, the Netherlands, the United Kingdom, Finland, Norway, Germany and Italy. 2 assumptions on the general functioning of economies. CGE modelling is an open standard tool for the analysis of the economy-wide impacts of environmental policies, including environmental tax issues, on resource allocation and the associated implications for incomes of different economic agents. They come from traditional input-output models initially developed by Leontief (1941). On the other hand, input-output models contain a simple representation of the interchanges between industries and other economic agents in a region during a specific temporal period. They can be easily build for impact analysis nowadays, as data needed (input-output tables) are usually available in official statistic institutes under national accounts. Leontief developed a straightforward method to assess exogenous shocks under certain restrictive assumptions like fixed technology. Later on, Leontief (1953) elaborated a dynamic input-output model providing more elements for the future development of general equilibrium modeling. Isard (1968) proposed a methodology based on input-output tables that related economic and environmental variables in order to offer more policy alternatives. Later, Kneese et al. (1970) used a similar input-output approach for environmental policy. These methods, however, maintain the assumption that environmental impacts or resource use are proportional to output, similarly than the fixed coefficients assumption of the traditional input-output model. So they do not allow technical change after an exogenous shock. These and other limitations encouraged researchers to develop more complex methods. Johansen (1960) was the first known who developed an empirical general equilibrium model without the fixed-coefficients assumption of input-output analysis. This research provides a comprehensive review on the literature of DD hypothesis of environmental taxation using CGE methods. After some decades of extensive use of these models for the analysis of the DD hypothesis it is time to provide an extensive review. We have analyzed studies from different countries and regions, using a wide variety of CGE models with two main objectives: (1) show the effects of an ETR in different contexts using different approaches of this modelling technique; and (2) investigate in which conditions a DD can be obtained. This research is structured as follows: section 2 describes the theoretical debate around the DD hypothesis; section 3 contains a comprehensive review on the empirical literature on the DD hypothesis and CGE models; section 4 conducts a statistical and meta-regression analysis of the reviewed studies and section 6 concludes. ACCEPTED MANUSCRIPT 2. Theoretical debate around the double dividend hypothesis While the theoretical basis of environmental taxes has been well documented (specially in early discussions from Baumol, 1972 and Baumol and Oates, 1971, 1988), this 3 section attempts to approach the main theoretical discussions around the DD question and CGE modelling. 2.1. The efficiency dividend This has been a topic of growing importance during the last three decades. Tullock (1967) argued that a Pigouvian tax could create a DD by internalizing external costs, as Pigou (1932)