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On optimal emission control – Taxes, substitution and business cycles

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  • Lintunen , Jussi

    ()
    (Finnish Forest Research Institute)

  • Vilmi, Lauri

    ()
    (Bank of Finland, Monetary Policy and Research Department)

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    Abstract

    This paper studies the cyclical properties of optimal emission taxes and emissions using a real business cycle model with a stock pollutant. We derive conditions for the procyclicality of optimal emission tax and show that the tax is in typical conditions procyclical. The possibility of a countercyclical behavior of the emission tax increases if 1) the pollution is short-lived and the emission transfer into environmental damages rapidly 2) emissions are countercyclical, 3) marginal damages are strongly increasing and 4), in disutility case, the marginal utility of consumption increases with the increase in the intensity of the harmful environmental process. In the climate change context we show that the optimal carbon tax is procyclical irrespectively on the production technology. Instead, the technology is a key determinant of the cyclicality of the emissions. The optimal carbon tax correlates almost fully with the consumption and as a rule-of thumb, it could be indexed to the consumption level of the economy. The relative scale of tax deviations relative to the consumption deviations is determined by the inverse of the intertemporal elasticity of substitution. Comparison between the optimal emission tax and an optimally set constant emission tax shows that the constant tax leads to very slightly higher emissions but the general economic effects are next to negligible.

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    File URL: http://www.suomenpankki.fi/en/julkaisut/tutkimukset/keskustelualoitteet/Documents/BoF_DP_1324.pdf
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    Bibliographic Info

    Paper provided by Bank of Finland in its series Research Discussion Papers with number 24/2013.

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    Length: 30 pages
    Date of creation: 09 Oct 2013
    Date of revision:
    Handle: RePEc:hhs:bofrdp:2013_024

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    Postal: Bank of Finland, P.O. Box 160, FI-00101 Helsinki, Finland
    Web page: http://www.suomenpankki.fi/en/
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    Keywords: optimal emission tax; cyclical properties;

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    1. Heutel, Garth, 2011. "How Should Environmental Policy Respond to Business Cycles? Optimal Policy under Persistent Productivity Shocks," Working Papers 11-8, University of North Carolina at Greensboro, Department of Economics.
    2. Weitzman, Martin L, 1974. "Prices vs. Quantities," Review of Economic Studies, Wiley Blackwell, Wiley Blackwell, vol. 41(4), pages 477-91, October.
    3. Daron Acemoglu & Philippe Aghion & Leonardo Bursztyn & David Hemous, 2010. "The Environment and Directed Technical Change," Working Papers 2010.93, Fondazione Eni Enrico Mattei.
    4. Newell, Richard G. & Pizer, William A., 2003. "Regulating stock externalities under uncertainty," Journal of Environmental Economics and Management, Elsevier, vol. 45(2, Supple), pages 416-432, March.
    5. Reyer Gerlagh, 2012. "Carbon Prices for the Next Thousand Years," Review of Environment, Energy and Economics - Re3, Fondazione Eni Enrico Mattei, August.
    6. Fischer, Carolyn & Springborn, Michael R., 2011. "Emissions Targets and the Real Business Cycle: Intensity Targets versus Caps or Taxes," Discussion Papers, Resources For the Future dp-09-47-rev, Resources For the Future.
    7. William D. Nordhaus, 1992. "Rolling the 'Dice': An Optimal Transition Path for Controlling Greenhouse Gases," Cowles Foundation Discussion Papers 1019, Cowles Foundation for Research in Economics, Yale University.
    8. Mikhail Golosov & John Hassler & Per Krusell & Aleh Tsyvinski, 2014. "Optimal Taxes on Fossil Fuel in General Equilibrium," Econometrica, Econometric Society, vol. 82(1), pages 41-88, 01.
    9. Newell, Richard G. & Pizer, William A., 2008. "Indexed regulation," Journal of Environmental Economics and Management, Elsevier, vol. 56(3), pages 221-233, November.
    10. Garth Heutel, 2011. "Online Appendix to "How Should Environmental Policy Respond to Business Cycles? Optimal Policy under Persistent Productivity Shocks"," Technical Appendices 10-62, Review of Economic Dynamics.
    11. William D. Nordhaus, 2007. "A Review of the Stern Review on the Economics of Climate Change," Journal of Economic Literature, American Economic Association, vol. 45(3), pages 686-702, September.
    12. Kelly, David L., 2005. "Price and quantity regulation in general equilibrium," Journal of Economic Theory, Elsevier, vol. 125(1), pages 36-60, November.
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