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Prices versus Quantities in a Second-Best Setting

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  • Philippe Quirion

Abstract

The choice between taxes and tradable permits has been independently analysed by two distinct research traditions. The first proceeds from Weitzman's partial equilibrium stochastic model and concludes that a tax should be preferred if the marginal abatement cost curve is steeper than the marginal environmental benefit curve. The second utilises deterministic general equilibrium models with pre-existing distortionary taxes. It concludes that non-revenue-raising instruments (e.g., grandfathered tradable permits) are costlier than revenue-raising ones (e.g., a tax on every unit of pollution or auctioned permits). To build a bridge between these two traditions, we introduce in Weitzman's model a positive cost of public funds due to pre-existing distortionary taxes. The tax admits a greater comparative advantage over the permits, as compared to Weitzman's classical result. Then, we assume that the regulated industry blocks any proposal that poses it too high an expected burden. This may require a transfer to firms, in the form of freely-allocated permits or lump-sum tax rebate. It turns out that if this acceptability constraint is binding, then the comparative advantage of taxes over permits is still reinforced. Quantitatively, even if the marginal benefit function is 50% more steeply sloped than the marginal cost function, the price instrument should be preferred. We also compare the expected net benefit of these two instruments to a contingent instrument which leads to the ex post optimum. The superiority of the contingent instrument over the quantity one is higher than in first-best. Copyright Kluwer Academic Publishers 2004

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Bibliographic Info

Article provided by European Association of Environmental and Resource Economists in its journal Environmental and Resource Economics.

Volume (Year): 29 (2004)
Issue (Month): 3 (November)
Pages: 337-360

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Handle: RePEc:kap:enreec:v:29:y:2004:i:3:p:337-360

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Web page: http://www.springerlink.com/link.asp?id=100263

Related research

Keywords: environmental taxes; policy choice; second best; tradable permits; uncertainty;

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  1. Ronnie Schöb, 1996. "Choosing the right instrument," Environmental & Resource Economics, European Association of Environmental and Resource Economists, vol. 8(4), pages 399-416, December.
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Citations

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Cited by:
  1. Vossler, Christian A. & Suter, Jordan F. & Poe, Gregory L., 2013. "Experimental evidence on dynamic pollution tax policies," Journal of Economic Behavior & Organization, Elsevier, vol. 93(C), pages 101-115.
  2. Villegas, Clara & Coria, Jessica, 2009. "Taxes, Permits, and the Adoptation of Abatement Technology under Imperfect Compliance," Discussion Papers dp-09-20-efd, Resources For the Future.
  3. Pezzey, John C.V. & Jotzo, Frank, 2010. "Tax-Versus-Trading and Free Emission Shares as Issues for Climate Policy Design," Research Reports 95049, Australian National University, Environmental Economics Research Hub.
  4. John K. Stranlund & Yakov Ben-Haim, 2006. "Price-Based vs. Quantity-Based Environmental Regulation under Knightian Uncertainty: An Info-Gap Robust Satisficing Perspective," Working Papers 2006-1, University of Massachusetts Amherst, Department of Resource Economics.
  5. Clara Villegas-Palacio & Jessica Coria, 2010. "On the interaction between imperfect compliance and technology adoption: taxes versus tradable emissions permits," Journal of Regulatory Economics, Springer, vol. 38(3), pages 274-291, December.
  6. Gilbert E. Metcalf, 2008. "Designing A Carbon Tax to Reduce U.S. Greenhouse Gas Emissions," NBER Working Papers 14375, National Bureau of Economic Research, Inc.
  7. Fischer, Carolyn & Laxminarayan, Ramanan, 2010. "Managing partially protected resources under uncertainty," Journal of Environmental Economics and Management, Elsevier, vol. 59(2), pages 129-141, March.
  8. Frank Jotzo & John C. V. Pezzey, 2006. "Optimal Intensity Targets for Greenhouse Emissions Trading Under Uncertainty," Economics and Environment Network Working Papers 0605, Australian National University, Economics and Environment Network.
  9. Susana Ferreira, 2007. "Trade Policy and Natural Resource Use: The Case for a Quantitative Restriction," Environmental & Resource Economics, European Association of Environmental and Resource Economists, vol. 37(2), pages 361-376, June.
  10. Peter J. Wood & Peter Heindl & Frank Jotzo & Andreas Löschel, 2013. "Linking Price and Quantity Pollution Controls under Uncertainty," CCEP Working Papers 1302, Centre for Climate Economics & Policy, Crawford School of Public Policy, The Australian National University.
  11. Alain-Désiré Nimubona & Ujjayant Chakravorty & Andrew Leach, 2014. "The Search for Abatement Technologies in the Alberta Oil Sands," CESifo Working Paper Series 4781, CESifo Group Munich.
  12. Carlos Chávez & John Stranlund, 2009. "A Note on Emissions Taxes and Incomplete Information," Environmental & Resource Economics, European Association of Environmental and Resource Economists, vol. 44(1), pages 137-144, September.
  13. Moritz Rohling & Markus Ohndorf, 2010. "Prices vs. Quantities with Fiscal Cushioning," IED Working paper 10-11, IED Institute for Environmental Decisions, ETH Zurich.
  14. Pezzey, John C.V. & Jotzo, Frank, 2012. "Tax-versus-trading and efficient revenue recycling as issues for greenhouse gas abatement," Journal of Environmental Economics and Management, Elsevier, vol. 64(2), pages 230-236.
  15. Frank Jotzo & John C. V. Pezzey, 2005. "Optimal intensity targets for emissions trading under uncertainty (now replaced by EEN0605)," Economics and Environment Network Working Papers 0504, Australian National University, Economics and Environment Network.

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