Environmental policy and the equilibrium rate of unemployment

This paper integrates environmental policy instruments with the theory of equilibrium unemployment. We investigate the question of whether a low equilibrium rate of unemployment and a high quality of the environment are complementary policy goals or must be traded off. It turns out that an interval exists for a tax on emissions where the two goals are indeed complementary. The tax stimulates the emergence of an abatement sector which provides pollution control and vacancies for the job seekers. For constrained efficiency, the policy maker operates five instruments to internalize the environmental and the search externalities. A tax on emissions, employment subsidies and recruiting allowances for the polluting industries are sufficient to implement the first-best. The optimal emission tax is an increasing function of the workers' bargaining strength. For labor markets where workers have a strong bargaining position, the optimal pollution tax may easily exceed the Pigouvian tax. (C) 2004 Elsevier Inc. All rights reserved.