Working Paper: NBER ID: w15262
Authors: Stephen P. Holland
Abstract: This paper investigates whether an emissions tax (equivalent to an emissions cap) maximizes social welfare (defined as the sum of consumer and producer surplus) in the presence of incomplete regulation (leakage) or market power by analyzing an intensity standard regulating emissions per unit of output. With no other market failures, an intensity standard indeed yields lower welfare, although combining it with a consumption tax eliminates this discrepancy. For incomplete regulation, I show that under certain conditions an intensity standard can yield higher welfare than any emissions tax (including the optimal emissions tax). This result persists even with the addition of a consumption tax, which ameliorates output distortions and can sometimes help the intensity standard attain the first best (when an emissions tax/consumption tax combination cannot). Comparing intensity standards to output-based updating shows that the latter yields higher welfare because of its additional flexibility. Finally, I show that with market power an intensity standard can yield higher welfare than the optimal emissions tax. \n \nThe intuition of these results is relatively straightforward. The weakness of an intensity standard is that it relies more on substitution effects than output effects to reduce emissions. With incomplete regulation or market power, this disadvantage may be helpful since leakage may offset gains from reducing output and since market power already inefficiently reduces output.
Keywords: Environmental Economics; Emissions Tax; Intensity Standard; Market Power
JEL Codes: H23; Q40; Q50
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| emissions tax (Q58) | efficient emissions reductions (Q52) |
| emissions cap (Q58) | efficient emissions reductions (Q52) |
| intensity standard (L94) | not achieve efficiency (D61) |
| intensity standard + consumption tax (H29) | higher welfare than emissions tax (D62) |
| intensity standard (L94) | substitution effects (D11) |
| intensity standard (L94) | output effects (E23) |
| intensity standard + consumption tax (H29) | first-best outcomes (H21) |
| intensity standard under monopoly (D42) | higher welfare than optimal emissions tax (D62) |
| intensity standard's dual role (L94) | higher overall welfare (D69) |