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Efficiency Costs of Meeting Industry-Distributional Constraints under Environmental Permits and Taxes


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  • Bovenberg, A.L.
  • Goulder, L.H.
  • Gurney, D.J.

    (Tilburg University, Center for Economic Research)


Many pollution-related industries wield strong political influence and can e.ectively veto policy initiatives that would harm their profits.A politically realistic approach to environmental policy therefore seems to require the alleviation of significant profitlosses to these industries.The regulatory authority can do this by freely allocating some emissions permits or by exempting some inframarginal emissions from a pollution tax.However, such policies compel the government to forego an e.cient potential revenue source and to rely more heavily on ordinary distortionary taxes.As a result, achieving distributional objectives comes at a cost in terms of e.ciency.Using analytically and numerically solved equilibrium models, we analyze the e.- ciency costs implied by the distributional constraint that adverse impacts on profits in particular industries must be avoided.Both models indicate that the e.ciency cost implied by this constraint dwarfs the other e.ciency costs when the required amount of abatement is very small.When the abatement requirement becomes more extensive, however, the cost of this constraint diminishes relative to the other e.ciency costs of pollution-control.We also calculate the compensation ratio: the share of potential policy revenue that the government must forego to protect the industries in question.We show how this ratio is a.ected by the extent of abatement, supply and demand elasticities, and the potential for end-of-pipe treatment.One definition of this ratio corresponds to the share of pollution permits that must be freely allocated to prevent profit-losses in the targeted industries.Numerical simulations of sulfur dioxide pollution-control suggest that the Bush Administration s Clear Skies Initiative would exceed this ratio, freely allocating more permits than necessary to preserve profits.Our models also highlight significant di.erences between gross and net policy revenues: when abatement is extensive, a large fraction of the revenue collected from emissions permits or taxes is o.set by the revenue-loss from erosion of the base of existing factor taxes.

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Bibliographic Info

Paper provided by Tilburg University, Center for Economic Research in its series Discussion Paper with number 2003-86.

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Date of creation: 2003
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Handle: RePEc:dgr:kubcen:200386

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Keywords: efficiency; costs; environmental tax; pollution; environmental policy;

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  1. Farrow, Scott, 1999. "The duality of taxes and tradable permits: A survey with applications in Central and Eastern Europe," Environment and Development Economics, Cambridge University Press, vol. 4(04), pages 519-535, October.
  2. Goulder, Lawrence H. & Parry, Ian W. H. & Williams III, Roberton C. & Burtraw, Dallas, 1999. "The cost-effectiveness of alternative instruments for environmental protection in a second-best setting," Journal of Public Economics, Elsevier, vol. 72(3), pages 329-360, June.
  3. Lawrence Goulder, 1995. "Environmental taxation and the double dividend: A reader's guide," International Tax and Public Finance, Springer, vol. 2(2), pages 157-183, August.
  4. Burtraw, Dallas & Palmer, Karen & Bharvirkar, Ranjit & Paul, Anthony, 2002. "The Effect on Asset Values of the Allocation of Carbon Dioxide Emission Allowances," The Electricity Journal, Elsevier, vol. 15(5), pages 51-62, June.
  5. Ian W.H. Parry & Wallace E. Oates, 2000. "Policy analysis in the presence of distorting taxes," Journal of Policy Analysis and Management, John Wiley & Sons, Ltd., vol. 19(4), pages 603-613.
  6. Newell, Richard & Anderson, Soren, 2003. "Prospects for Carbon Capture and Storage Technologies," Discussion Papers dp-02-68, Resources For the Future.
  7. Lawrence H. Goulder & Ian W. H. Parry & Dallas Burtraw, 1996. "Revenue-Raising vs. Other Approaches to Environmental Protection: The Critical Significance of Pre-Existing Tax Distortions," NBER Working Papers 5641, National Bureau of Economic Research, Inc.
  8. Parry Ian W. H., 1995. "Pollution Taxes and Revenue Recycling," Journal of Environmental Economics and Management, Elsevier, vol. 29(3), pages S64-S77, November.
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