Optimal tax policy in the presence of productive, consumption, and leisure externalities

This paper presents the optimal tax policy in an economy featuring consumption, production, and leisure externalities. This extends prior models that only consider consumption and production externalities. The immediate consequence is labor income should be taxed (subsidized) if the leisure externality is positive (negative). In addition, numerical simulations show that in the presence of positive production externalities, and irrespective of the sign of consumption externalities, an increase in the importance of the leisure externality reduces the distortion generated by consumption and production externalities. This effect is reversed if production externalities are negative.