TIME INCONSISTENCY IN ENVIRONMENTAL POLICY: TAX EARMARKING AS A COMMITMENT SOLUTION

Published in Economic Journal, 2000, vol.110, no.462, pp. C123-C138.

Laura Marsiliani
Thomas I. Renström

Tax earmarking imposes a constraint on government policymaking, and may be desirable if it solves a time-inconsistency problem in tax policy. In a two-period economy, in which the policy decisions regarding taxes, public goods provision, and pollution abatement are taken by a majority-elected individual, we show how the time-inconsistency problem in environmental policy arises. We demonstrate that the commitment equilibrium under no earmarking rules cannot be fully implemented as a no-commitment equilibrium under earmarking rules. However, the earmarking rules do act as a partial commitment mechanism.

Keywords:Tax earmarking, fiscal policy, redistributive taxation, endogenous taxation, time inconsistency, environmental tax, pollution abatement.

JEL classification: D62, D72, E62, H20.

Correspondence to:
L. Marsiliani, Department of Economics and Finance, University of Durham, 23-26 Old Elvet, Durham, DH1 3HY,
UK. Tel: +44-(0)191-334 6363. Fax: +44-(0)191-334 6341.
Email: [email protected] Web: http://www.dur.ac.uk/~dec0lm/

T.I. Renström, Department of Economics and Finance, University of Durham, 23-26 Old Elvet, Durham, DH1 3HY,
UK. Tel: +44-(0)191-334 6369. Fax: +44-(0)191-334 6341.
Email: [email protected] Web: http://www.dur.ac.uk/t.i.renstrom/

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