Environmental Feedbacks and Optimal Taxation in Oligopoly

The paper analyses the problem of optimal taxation in oligopoly when environmental degradation induced by the industry production process feeds back into market demand. The main assumption is that economic agents and the policy-maker care about the environment only because its degradation affects the industry's economic performance. The environment does not enter directly either into the utility function or into the social welfare function. We consider an industry in which n asymmetric firms compete à la Cournot. Each firm is subject to the same environmental legislation, either because they belong to the same country, or because environmental policy is internationally coordinated. Asymmetry arises because firms use different technologies (their marginal costs differ). The first part of the paper focuses on the comparative static effects of the environmental tax. We show that market share and profits of some firms can increase when the tax rate is raised if environmental feedbacks are sufficiently high and the industry is not very asymmetric. Moreover, the relationship between industry concentration and emission taxation is explored. The second part of the paper faces the problem of optimal taxation. We show that there may exist an optimal tax such that some firms increase their profits and/or their market share. Moreover, the optimal tax rate is inversely related to the industry asymmetry (the variance of firms' marginal costs), and positively related to the perceived environmental damage.