Investigating the impact of an optimal fiscal policy on the Iran economy with externality based on the Ramsey solution

Based on the literature on pollution tax on capital and labor, we have analyzed the impact of an optimal fiscal policy (tax) on the Iran economy based on the Ramsey solution. To achieve this, we created a dynamic economic-climatic model for the Iranian economy by adding externalities to a simple general equilibrium model without a foreign sector. Thus first we developed a dynamic model in two cases with and without side effects. Findings indicate that in the conditions of no pollution of the production sector, the model reaches equilibrium with zero capital tax. When we take into account the pollution in the model, in order to have a unique optimal point and keep the economy on the saddle path and it converged towards an optimal point, so capital-based  pollution tax became essential. In our model, endogenous labor plays an important role as it indicates an increase in household environmental awareness, the supply of working hours, consumption, production, and environmental quality. In the models with exogenous labor, low household awareness of environmental quality leads to more severe degradation of environmental quality. According to our results considering the Ramsey solution on the economy, in a situation where: labor is endogenous, capital-based pollution tax is implemented, with a dynamic general economic-climatic equilibrium model, two environmental parameters are vital to be taken care of, “the weight of environmental quality” and “the polluting technology”. In an environment where we use increasingly polluting technology, in the absence of an increasing pollution tax regime, the quality of the environment and society's welfare will diminish subsequently.

Keywords:

dynamic optimal control model , pollution tax , Small open economy , Ramsey model