Optimal Taxation and Innovation in the Presence of Externalities
Creators: name: Hosseini, Hossein
Publisher: name: Arts
Year: 2018
Subjects: subject: Optimal Income Taxation
subject: Consumption Externalities
subject: Biased Technological Change
subject: Intellectual Property Rights
subject: Education--Social Sciences
subject: Economics
subject: Public and Social Welfare
subject: Environmental Sciences

description: The title of my thesis is “Optimal Taxation and Innovation in the Presence of Externalities.” It explores the effects of externalities on optimal income taxation and innovation. On the one hand, governments’ income redistribution policies among households affect pollution since households are different in terms of how much they pollute. This affects the design of an optimal income tax schedule. On the other hand, externalities affect the bias of technological change over time and also how much sectors (or countries) innovate. Firstly, scarcity rents induce biased innovation in the natural resource sector over time, which has important implications for fossil fuels’ prices and production. Secondly, spillovers from innovative activities among sectors (or countries) affect how much they innovate and necessitate policies, such as patents, to overcome this market failure. The first chapter of my thesis is titled “Optimal Income Taxation in the Presence of Consumption Externalities”. This paper characterizes an optimal income tax and transfer system considering the effects of income redistribution on pollution. Low-income households pollute more per dollar of consumption than high-income households. Therefore, redistributing income towards low-income households can increase pollution. This paper modifies an optimal income taxation model and derives the optimal tax rates that maximize welfare while considering pollution. Income tax provides revenue for the government and results in welfare loss to those who pay taxes. This paper takes into account the fact that income tax also affects pollution through both redistributing income and changing the amount that people work. I derive the optimal income tax rates using the pollution intensities of U.S. households at different income levels. The results show that optimal marginal tax rates are lower and the optimal tax schedule is substantially less progressive compared to models that ignore pollution. This is important because the effect of the current U.S. income tax and transfers on pollution is not trivial. I find that, annually, the U.S. income tax and transfer system contributes roughly 6-9 percent to aggregate pollution of households. This paper further demonstrates that income taxes can complement other policies to efficiently reduce pollution. Market power and scarcity rents, as other kinds of externalities, can bias technological change in the natural resource sector. The second chapter of my thesis is titled “The Upstream Bias in Technological Change with Exhaustible Resources”. This paper focuses on the implications of the bias of technological change in the natural resource sector. In this paper, I collaborate with Dr. John Boyce, a Professor of Economics at the University of Calgary. The main stylized fact that motivates the paper is that for eighty minerals over the past century, exhaustible resource prices have been falling relative to incomes and exhaustible resource production has been rising. In contrast to Hotelling’s theory of exhaustible resources, long-term trends show falling resource prices and rising resource production. We explain this using a theory of an exhaustible resource economy where R&amp;D is endogenously targeted either to the upstream exhaustible resource sector or to the downstream final good sector. An upstream bias in technological change explains the observed trends. This bias is attributed to a low relative upstream state of technology and low scarcity for exhaustible resources. The bias in R&amp;D eventually switches to the downstream sector. Thereafter, exhaustible resource prices rise and exhaustible resource production falls. Per capita consumption grows and the mining share of labor falls all along the equilibrium. In addition to the bias of innovation over time, spillovers of innovative activities among sectors (or countries) provide a positive externality that results in too little innovation in a competitive market. To overcome this market failure and fully reward innovative efforts, many countries commonly use Intellectual Property Rights (IPRs), such as patenting and copyrights. The third chapter of my thesis explores the effects of IPRs on innovation and economic growth. The title of this chapter is “Intellectual Property Rights and Innovation in a North-South Model”. IPRs encourage incentives for innovators but they also have welfare costs by providing innovators with monopoly power for a specific time frame. IPRs might also adversely affect future innovation since they make current discoveries less accessible for potential innovators. In the third chapter of my thesis, I incorporate this adverse effect of IPRs on subsequent innovators into a North-South dynamic general equilibrium model to investigate the overall effect of tighter IPRs on economic growth and welfare. In the model, the North innovates and the South imitates and tighter IPRs not only reduce the South’s imitation rate, but they also lower labour productivity in the R&amp;D sector in the North. The model’s results indicate that tighter IPRs hurt innovation in the long run. Moreover, in contrast to previous models, the short-run effect could also be negative. In addition, I decompose the welfare effects to four components: changes in (a) terms of trade (b) production composition (c) available products, and (d) intertemporal composition of consumption. The model’s results show that tighter IPRs may hurt both the North and the South on account of all these four welfare components, except for the terms of trade from which the North benefits and the South loses.