Are short‐term effects of pollution important for growth and optimal fiscal policy?

• Published date: 01 September 2020
• DOI: http://doi.org/10.1111/jpet.12438
• Date: 01 September 2020

J Public Econ Theory. 2020;22:1262–1288.wileyonlinelibrary.com/journal/jpet1262

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© 2020 Wiley Periodicals, Inc.

Received: 16 August 2018

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Accepted: 14 February 2020

DOI: 10.1111/jpet.12438

ORIGINAL ARTICLE

Are short‐term effects of pollution important

for growth and optimal fiscal policy?

Sugata Ghosh

1

|Trishita Ray Barman

2

|Manash Ranjan Gupta

3

1

Department of Economics and Finance,

Brunel University, Uxbridge,

Middlesex, UK

2

Department of Economics, Shiv Nadar

University, Gautam Buddha Nagar,

Uttar Pradesh, India

3

Economics Research Unit, Indian

Statistical Institute, Kolkata, West Bengal,

India

Correspondence

Trishita Ray Barman, Department of

Economics, Shiv Nadar University, NH‐91

Tehsil Dadri, Gautam Buddha Nagar

201314, UP, India.

Email: trbarman@gmail.com

Abstract

We study optimal fiscal policy in a stock‐flow model

of the environment within an endogenous growth

framework, where some pollutants have a lasting

impact on environmental quality which is restored

through abatement expenditure, while others dis-

sipate and hence, have a short‐term effect on the

environment. All pollutants, however, affect the

productivity of a public good negatively. Given that

short‐term pollution, although it dissipates, is irre-

versible in this sense, a government cannot ignore its

negative effects since this type of pollution lowers the

productivity of all inputs. We find that a larger ne-

gative effect of short‐term pollutants as well as a

higher congestion effect of private capital leads to

corrective fiscal policies with higher optimal income

tax and abatement expenditure rates, which have

favorable growth consequences. Interestingly, we

find that the rate of short‐term pollution does not

affect optimal fiscal policy while that of the long‐term

pollution does.

1|INTRODUCTION

Future generations would be worse off if unsustainable consumption and investment patterns

of today translate after a time lag into environmental disruption, as Smulders (1995) points out.

The challenge, therefore, is to achieve sustained economic growth with maximum achievable

social welfare levels preserving the quality of the environment as much as possible. Since fiscal

policy can be used to attain such objectives, it is appropriate to understand the nature of

taxation and expenditure policies that could effectively counter environmental pollution while

preserving growth prospects. In this paper, we study two different kinds of impact of en-

vironmental pollution on optimal fiscal policies. Some types of pollution generate flow effects

while some other types generate long‐term effects on environmental quality which accumulate

over time, like a stock variable. To the best of our knowledge, the dissipating and the lasting

effects of pollution have not been studied simultaneously in the dynamic endogenous growth

models available in the existing environment‐growth literature.

An important issue in this context is the distinction not only between stocks and flows but

also between long‐term (permanent) effects and short‐term (dissipating) effects.

1

Some pollu-

tants, or part of them, dissipate or are absorbed by the environment. So, they do not stay on in

the environment long enough to have lasting impacts on it. On the other hand, those pollutants

which stay on and have negative effects on the environment affect the stock of environmental

quality. It is well known why abatement activities are necessary to curb long‐term pollution.

However, what is less obvious, and therefore, required, is to examine the need to control short‐

term pollutants. Even if they dissipate, it may be necessary to control short‐term pollutants

because these pollutants can also produce substantial negative effects on productivity.

Environmental pollution affects the productivity of inputs in various ways. In particular, we

follow Ray Barman and Gupta (RBG, 2010) to model the way the services from public infra-

structure are adversely affected by pollution, and the manner in which the productivity of

private capital is affected in the process. One could think of a public good, like a highway being

corroded by acid rain, which is caused by the prolonged presence of atmospheric pollutants, like

sulphur dioxide, nitrous oxide, and so forth; or, in other words, by the degradation of the stock

of environmental quality as a whole which causes the acid rains. This could result in potholes

slowing movement of traffic and can cause hazards, like accidents too. Pollutants causing acid

rain are instrumental in corroding not only roads, but also buildings and other physical in-

frastructure. This damage may be prevented by maintaining the stock of environmental quality

if adequate expenditure is made on abatement.

This highway example can also be used to capture the short‐term effects of pollution in the

production function. For example, vehicle drivers on the highways are slowed down because of

drop in visibility caused by the presence of smog. However, the smog usually disappears after a

point in time, and the driver can revert to their original speed. This is an example

2

of the short‐

term effect of certain pollutants that affects efficiency for some time.

We attempt to capture the simultaneous impact of stock and flow effects of pollutants on

growth in a unified framework. Lieb (2004) also considers the simultaneous occurrence of stock

1

The stock‐flow distinction mentioned here in the context of environment as a public good is different from that made

in the context of public goods, in general. In the context of public goods it involves the long‐term goal of the accu-

mulation of public capital—for example, building of infrastructure networks (stocks)—and the short‐term need to

provide public services—for example, maintenance of such networks (flows). And governments routinely have to face

trade‐offs between these two objectives. A model of public goods having both a stock as well as a flow component is

captured by Ghosh and Roy (2004). However, even the short‐term maintenance expenditure made in case of other

public good stocks is to keep the stock of public good in running condition so that the flow of services from it continues

to flow unabated. So, whether it is augmenting of the stock or maintaining it, the stock of public good is affected. This is

not so with short‐term pollution, which is part of total flow of emissions, as we model in our paper here. It does not

affect the stock of environmental quality and yet has productivity effects, independently.

2

Other examples of flow effects of pollutants can be provided. Biodegradable waste and sewage in water makes it unfit

for use in agriculture or factories. Depletion of nitrogenous compounds due to intensive cropping, though eventually

replenished by nature, affects current harvest. Brick kilns cannot use clay polluted by sewage waste. These are examples

of short‐term pollution affecting productivity. On the other hand, long‐term pollution, like soil quality degradation due

to the presence of lead, the chemical effluents from one industry impacting another industry using the same water

source, and so forth, clearly has long‐term negative impact on industrial production.

GHOSH ET AL.

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