Taxing polluting resources: growth, welfare and consumption inequality

Abstract This paper develops a Romer (1990)‐type endogenous growth model that incorporates polluting non‐renewable resources and heterogeneous households with varying asset holdings. It contributes to the literature on the taxation of polluting exhaustible resources by examining its impact on consumption inequality, with particular emphasis on the role of natural resources as household assets. In the model, the stock of pollution—accumulating through resource use—affects social welfare. We show that, when distortions from intertemporal knowledge spillovers are not fully corrected, environmental tax policies that slow resource extraction and mitigate the welfare costs of pollution can foster economic growth but exacerbate consumption inequality. To promote growth and reduce the welfare damage caused by pollution without increasing inequality, environmental tax revenues should be allocated for redistributive purposes. Lastly, the paper calibrates the model for quantitative analysis and explores environmental tax policies that maximize social welfare under limited government capacity to correct knowledge spillover distortions, relying on environmental tax revenues for redistribution.