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Taxes and Trading versus Intensity Standards: Second-Best Environmental Policies with Incomplete Regulation (Leakage) or Market Power

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  • Stephen P. Holland

Abstract

This paper investigates whether an emissions tax (equivalent to an emissions cap) maximizes social welfare (defined as the sum of consumer and producer surplus) in the presence of incomplete regulation (leakage) or market power by analyzing an intensity standard regulating emissions per unit of output. With no other market failures, an intensity standard indeed yields lower welfare, although combining it with a consumption tax eliminates this discrepancy. For incomplete regulation, I show that under certain conditions an intensity standard can yield higher welfare than any emissions tax (including the optimal emissions tax). This result persists even with the addition of a consumption tax, which ameliorates output distortions and can sometimes help the intensity standard attain the first best (when an emissions tax/consumption tax combination cannot). Comparing intensity standards to output-based updating shows that the latter yields higher welfare because of its additional flexibility. Finally, I show that with market power an intensity standard can yield higher welfare than the optimal emissions tax. The intuition of these results is relatively straightforward. The weakness of an intensity standard is that it relies more on substitution effects than output effects to reduce emissions. With incomplete regulation or market power, this disadvantage may be helpful since leakage may offset gains from reducing output and since market power already inefficiently reduces output.

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Bibliographic Info

Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 15262.

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Date of creation: Aug 2009
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Publication status: published as “Taxes and Trading versus Intensity Standards: Second - Best Environmental Policies with Incomplete Regulation (Leakage) or Market Power” Journal of Environmental Economics and Management (2012) 63 (3): 375 – 387 .
Handle: RePEc:nbr:nberwo:15262

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  1. Bushnell, James & Chen, Yihsu, 2009. "Regulation, Allocation and Leakage in Cap-And-Trade Markets for CO2," Staff General Research Papers, Iowa State University, Department of Economics 13131, Iowa State University, Department of Economics.
  2. Erin T. Mansur, 2007. "Prices vs. Quantities: Environmental Regulation and Imperfect Competition," NBER Working Papers 13510, National Bureau of Economic Research, Inc.
  3. Fischer, Carolyn, 2003. "Output-Based Allocation of Environmental Policy Revenues and Imperfect Competition," Discussion Papers, Resources For the Future dp-02-60, Resources For the Future.
  4. Don Fullerton & Robert D. Mohr, 2002. "Suggested Subsidies are Sub-optimal Unless Combined with an Output Tax," NBER Working Papers 8723, National Bureau of Economic Research, Inc.
  5. Barnett, A H, 1980. "The Pigouvian Tax Rule under Monopoly," American Economic Review, American Economic Association, American Economic Association, vol. 70(5), pages 1037-41, December.
  6. Stephen P. Holland & Christopher R. Knittel & Jonathan E. Hughes, 2007. "Greenhouse Gas Reductions under Low Carbon Fuel Standards?," NBER Working Papers 13266, National Bureau of Economic Research, Inc.
  7. Newell, Richard G. & Pizer, William A., 2008. "Indexed regulation," Journal of Environmental Economics and Management, Elsevier, vol. 56(3), pages 221-233, November.
  8. Fischer, Carolyn, 2001. "Rebating Environmental Policy Revenues: Output-Based Allocations and Tradable Performance Standards," Discussion Papers, Resources For the Future dp-01-22, Resources For the Future.
  9. Carolyn Fischer & Alan K. Fox, 2007. "Output-Based Allocation of Emissions Permits for Mitigating Tax and Trade Interactions," Land Economics, University of Wisconsin Press, vol. 83(4), pages 575-599.
  10. Don Fullerton & Garth Heutel, 2007. "The General Equilibrium Incidence of Environmental Mandates," NBER Working Papers 13645, National Bureau of Economic Research, Inc.
  11. Lawrence H. Goulder & Ian W. H. Parry & Roberton C. Williams III & Dallas Burtraw, 1998. "The Cost-Effectiveness of Alternative Instruments for Environmental Protection in a Second-Best Setting," NBER Working Papers 6464, National Bureau of Economic Research, Inc.
  12. Bovenberg, A. Lans & Goulder, Lawrence H. & Jacobsen, Mark R., 2008. "Costs of alternative environmental policy instruments in the presence of industry compensation requirements," Journal of Public Economics, Elsevier, Elsevier, vol. 92(5-6), pages 1236-1253, June.
  13. Helfand, Gloria E, 1991. "Standards versus Standards: The Effects of Different Pollution Restrictions," American Economic Review, American Economic Association, American Economic Association, vol. 81(3), pages 622-34, June.
  14. Fischer, Carolyn & Fox, Alan K., 2009. "Comparing Policies to Combat Emissions Leakage: Border Tax Adjustments versus Rebates," Discussion Papers, Resources For the Future dp-09-02, Resources For the Future.
  15. Parry, Ian W.H. & Goulder, Lawrence H., 2008. "Instrument Choice in Environmental Policy," Discussion Papers, Resources For the Future dp-08-07, Resources For the Future.
  16. M. Ali Khan, 2007. "Perfect Competition," PIDE-Working Papers, Pakistan Institute of Development Economics 2007:15, Pakistan Institute of Development Economics.
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Cited by:
  1. Gori, Giuseppe Francesco & Lambertini, Luca, 2013. "Trade liberalisation between asymmetric countries with environmentally concerned consumers," Regional Science and Urban Economics, Elsevier, Elsevier, vol. 43(4), pages 549-560.
  2. Stephen P. Holland, 2010. "Spillovers from Climate Policy," NBER Working Papers 16158, National Bureau of Economic Research, Inc.
  3. Don Fullerton & Dan Karney & Kathy Baylis, 2011. "Negative Leakage," CESifo Working Paper Series 3379, CESifo Group Munich.
  4. Copeland, Brian R., 2012. "International trade and green growth," Policy Research Working Paper Series 6235, The World Bank.
  5. Stephen P. Holland & Jonathan E. Hughes & Christopher R. Knittel & Nathan C. Parker, 2011. "Some Inconvenient Truths About Climate Change Policy: The Distributional Impacts of Transportation Policies," NBER Working Papers 17386, National Bureau of Economic Research, Inc.
  6. Lemoine, Derek, 2013. "Escape from Third-Best: Rating Emissions for Intensity Standards," 2014 Allied Social Science Association (ASSA) Annual Meeting, January 3-5, 2014, Philadelphia, PA, Agricultural and Applied Economics Association 161656, Agricultural and Applied Economics Association.
  7. Stephen P. Holland, 2011. "Spillovers from Climate Policy to Other Pollutants," NBER Chapters, in: The Design and Implementation of U.S. Climate Policy, pages 79-90 National Bureau of Economic Research, Inc.

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