COWLES FOUNDATION FOR RESEARCH IN ECONOMICS
AT YALE UNIVERSITY

Box 208281
New Haven, CT 06520-8281

COWLES FOUNDATION DISCUSSION PAPER NO. 1576

Pareto Improving Taxes

J. D. Geanakoplos and H. M. Polemarchakis

August 2006

We show that in almost every economy with separable externalities, every competitive equilibrium can be Pareto improved by a package of anonymous commodity taxes that cause prices to adjust and markets to reclear at different levels of individual consumption. The argument can be extended to economies with strategic interactions, incomplete asset markets or asymmetric information. This constrained suboptimality of competitive allocations might provide a rationale for economic policy in economies with externalities.

Keywords: Externalities, Commodity taxes, Constrained suboptimality

JEL Classification Numbers: D50, D60, D62, D82