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The Impact of Policy Diffusion on Optimal Emission Taxes

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    Abstract

    We incorporate the process of policy diffusion (i.e. the uncoordinated dissemination of policies among countries) into a probabilistic two-country-model of strategic environmental policy. Contrary to the usual setting with simultaneous decision making we consider the impact of sequential decision making: In the first step the domestic government introduces an emission tax, in the second step policy diffusion occurs with a certain probability and in the third step the firms decide on output quantities. Within this framework we analyze how the prospect of policy diffusion, motivated by a higher damage parameter in the domestic country, influences the optimal domestic emission tax. We show that if the damage parameter in the foreign country is sufficiently high policy diffusion will occur which leads to higher tax rates and higher welfare compared to the equilibrium resulting from simultaneous decision making. Moreover, we show that an increase in the domestic tax rate also increases the probability that the foreign country adopts the tax policy.

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    File URL: http://www.wiwi.uni-augsburg.de/vwl/institut/paper/318.pdf
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    Paper provided by Universitaet Augsburg, Institute for Economics in its series Discussion Paper Series with number 318.

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    Length: pages
    Date of creation: Oct 2012
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    Handle: RePEc:aug:augsbe:0318

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    Keywords: strategic environmental policy; emission tax; policy diffusion; sequential decision-making;

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    1. Juan Carlos Bárcena-Ruiz, 2006. "Environmental Taxes and First-Mover Advantages," Environmental & Resource Economics, European Association of Environmental and Resource Economists, vol. 35(1), pages 19-39, September.
    2. Kennedy Peter W., 1994. "Equilibrium Pollution Taxes in Open Economies with Imperfect Competition," Journal of Environmental Economics and Management, Elsevier, vol. 27(1), pages 49-63, July.
    3. Eberhard Feess & Gerd Muehlheusser, 2002. "Strategic Environmental Policy, Clean Technologies and the Learning Curve," Environmental & Resource Economics, European Association of Environmental and Resource Economists, vol. 23(2), pages 149-166, October.
    4. Conrad Klaus, 1993. "Taxes and Subsidies for Pollution-Intensive Industries as Trade Policy," Journal of Environmental Economics and Management, Elsevier, vol. 25(2), pages 121-135, September.
    5. Simpson, R. David & Bradford, Robert III, 1996. "Taxing Variable Cost: Environmental Regulation as Industrial Policy," Journal of Environmental Economics and Management, Elsevier, vol. 30(3), pages 282-300, May.
    6. Rauscher, Michael, 2005. "International Trade, Foreign Investment, and the Environment," Handbook of Environmental Economics, in: K. G. Mäler & J. R. Vincent (ed.), Handbook of Environmental Economics, edition 1, volume 3, chapter 27, pages 1403-1456 Elsevier.
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