Controlling Environmental Pollution, Sectoral Composition and Factor Prices: A H–O and SFM Hybrid Approach

The consternation regarding environment is manifold. One of them is environmental quality which has both short-run and long-run implications including sustainable development goals. In view of such apprehension, this paper develops a Heckscher–Ohlin nugget kind of competitive general equilibrium model with four sectors and four factors of production to analyse the effect of tax policy to curb environmental pollution. Surprisingly we find that environmental tax on the polluting sector eventually raises the production of polluting output and widens the wage inequality between skilled and unskilled labour. On the other hand, taxing the non-polluting sector yields the desired outcome in both production and factor income. The possibility of vanishing sector strengthens the counterintuitive results we get in case of taxing the non-polluting sector. Such an intriguing outcome is driven by the recursive nature of structure of the H–O nugget model. We empirically test the efficacy of environmental taxes using a system-GMM dynamic panel data on 10 OECD countries for 1997–2020 and find that environmental taxes have a deleterious effect on the environmental quality.