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When Can Carbon Abatement Policies Increase Welfare? The Fundamental Role of Distorted Factor Markets

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  • Ian W. H. Parry
  • Roberton C. Williams III
  • Lawrence H. Goulder

Abstract

This paper employs analytical and numerical general equilibrium models to assess the efficiency impacts of two policies to reduce U.S. carbon emissions -- a carbon tax and a carbon quota -- taking into account the inter- actions between these policies and pre-existing tax distortions in factor markets. We show that tax interactions significantly raise the costs of both policies relative to what they would be in a first-best setting. In addition, we show that these interactions put the carbon quota at a signficant efficiency disadvantage relative to the carbon tax: the costs of reducing emissions by 10 % are more than three times higher under the carbon quota than than under the carbon tax. This disadvantage reflects the inability of the quota policy to generate revenue that can be used to reduce pre-existing dis- tortionary taxes. Indeed, second-best considerations severely limit the potential of a carbon quota to general overall efficiency gains. Under our central estimates, a non-auctioned carbon quota (or set of grandfathered carbon emissions permits) cannot increase efficiency unless the marginal benefits from avoided future climate change are at least $25 per ton of carbon abatement. Most estimates of these marginal environmental benefits are well below $25 per ton. Thus, our analysis suggests that any carbon abatement by way of a non-auctioned quota will be efficiency-reducing. In contrast, a revenue-neutral carbon tax is found to be efficiency-improving so long as marginal environmental benefits are positive.

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Bibliographic Info

Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 5967.

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Date of creation: Mar 1997
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Handle: RePEc:nbr:nberwo:5967

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Blog mentions

As found by EconAcademics.org, the blog aggregator for Economics research:
  1. Cap-and-Trade, Carbon Taxes, and My Neighbor’s Lovely Lawn
    by Robert Stavins in An Economic View of the Environment on 2012-10-21 17:25:30
  2. Pricing Carbon: Where We’ve Been, Where We Are And Where We May Be Going
    by Climate Guest Blogger in Think Progress on 2012-11-12 14:50:31

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  1. > Environmental and Natural Resource Economics > Climate economics > Abatement costs
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