Working Paper: NBER ID: w16268
Authors: Louis Kaplow
Abstract: This essay revisits the question of instrument choice for the regulation of externalities in the context of climate change. The central point is that the Pigouvian prescription to equate marginal control costs with the expected marginal benefits of damage reduction should guide the design of both carbon taxes and permit schemes. Because expected marginal damage rises nonlinearly, a corresponding nonlinear tax - or an equivalent price implemented through a quantity-adjusted permit scheme - is second best. Also considered are political factors, distinctive features of regulating a stock pollutant, and ex ante distortions due to the anticipation of transition relief (such as by receiving more free permits for greater emissions). Finally, distributive concerns are examined, with emphasis on the conceptual and practical benefits of addressing distributive issues with the tax and transfer system rather through adjustments to regulatory schemes that usually render them less effective.
Keywords: climate change; carbon taxes; permit schemes; externalities; regulation
JEL Codes: D61; D62; H21; H23; K32; Q52; Q54; Q58
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Marginal tax rate (H29) | Expected marginal harm from emissions (Q52) |
| Nonlinear taxes (H29) | Expected marginal harm (D81) |
| Choice between taxes and permits (H29) | Environmental outcomes (Q56) |
| Steeper marginal control costs (D40) | Superior taxes (H29) |
| Adjustments in permit quantities (R48) | Adjustments in tax rates (H29) |