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Neutralizing the Adverse Industry Impacts of CO2 Abatement Policies: What Does It Cost?

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Goulder, Lawrence
Bovenberg, A. Lans

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Abstract

The most cost-effective policies for achieving CO2 abatement (e.g., carbon taxes) are considered politically unacceptable because of distributional consequences. This paper explores policies designed to address distributional concerns. Using an intertemporal, numerical general equilibrium model of the United States, we examine how efficiency costs change when CO2 abatement policies include elements that neutralize adverse impacts on energy industries. We find that desirable distributional outcomes can be achieved at relatively low cost in terms of efficiency. Without substantial added cost to the overall economy, the government can implement carbon abatement policies that protect profits and equity values in fossil-fuel industries. The key to this conclusion is that CO2 abatement policies have the potential to generate rents that are very large in relation to the potential loss of profit. By enabling firms to retain only a very small fraction of these potential rents, the government can protect firms’ profits and equity values. Consequently, the government needs to grandfather only a small percentage of CO2 emissions permits or, similarly, must exempt only a small fraction of emissions from the base of a carbon tax. Each of these government policies involves only a small sacrifice of potential government revenue. Such revenue has an efficiency value because it can be used to finance cuts in pre-existing distortionary taxes. Because these policies give up little of this potential revenue, they involve only a small sacrifice in terms of efficiency. We also find that there is a very large difference between preserving firms’ profits and preserving their tax payments. Allowing firms to enjoy a dollar-for-dollar offset to their payments of carbon taxes—for example, through industry-specific cuts in corporate tax rates—substantially overcompensates firms, raising profits and equity values significantly relative to the unregulated situation. This reflects the fact that producers can shift onto consumers most of the burden from a carbon tax. The efficiency costs of such policies are far greater than the costs of policies that do not overcompensate firms.

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Paper provided by Resources For the Future in its series Discussion Papers with number dp-00-27.

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Date of creation: 01 Jul 2000
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Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
  1. Nicholas Bull & Kevin A. Hassett & Gilbert E. Metcalf, 1994. "Who Pays Broad-Based Energy Taxes? Computing Lifetime and Regional Incidence," The Energy Journal, International Association for Energy Economics, vol. 15(3), pages 145-164.
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  2. Lawrance, Emily C, 1991. "Poverty and the Rate of Time Preference: Evidence from Panel Data," Journal of Political Economy, University of Chicago Press, vol. 99(1), pages 54-77, February. [Downloadable!] (restricted)
  3. Bovenberg, A Lans & de Mooij, Ruud A, 1997. "Environmental Levies and Distortionary Taxation: Reply," American Economic Review, American Economic Association, vol. 87(1), pages 252-53, March. [Downloadable!] (restricted)
  4. Buchanan, James M & Tullock, Gordon, 1975. "Polluters' Profits and Political Response: Direct Controls Versus Taxes," American Economic Review, American Economic Association, vol. 65(1), pages 139-47, March. [Downloadable!] (restricted)
  5. A. Lans Bovenberg & Lawrence H. Goulder, 1995. "Costs of Environmentally Motivated Taxes in the Presence of Other Taxes:General Equilibrium Analyses," NBER Working Papers 5117, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  6. Robert E. Hall, 1988. "Intertemporal Substitution in Consumption," NBER Working Papers 0720, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  7. Don Fullerton & Gilbert Metcalf, 1997. "Environmental Controls, Scarcity Rents, and Pre-Existing Distortions," NBER Working Papers 6091, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  8. Gilbert E. Metcalf, 1998. "A Distributional Analysis of an Environmental Tax Shift," Discussion Papers Series, Department of Economics, Tufts University 9801, Department of Economics, Tufts University. [Downloadable!]
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  9. Lawrence H. Summers, 1981. "Taxation and Corporate Investment: A q-Theory Approach," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 12(1981-1), pages 67-140. [Downloadable!]
  10. John Pezzey, 1992. "The Symmetry between Controlling Pollution by Price and Controlling It by Quantity," Canadian Journal of Economics, Canadian Economics Association, vol. 25(4), pages 983-91, November. [Downloadable!] (restricted)
  11. Bovenberg, A Lans & Goulder, Lawrence H, 1996. "Optimal Environmental Taxation in the Presence of Other Taxes: General-Equilibrium Analyses," American Economic Review, American Economic Association, vol. 86(4), pages 985-1000, September. [Downloadable!] (restricted)
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  12. A. Lans Bovenberg & Lawrence H. Goulder, 2001. "Environmental Taxation and Regulation," NBER Working Papers 8458, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  13. Jorgenson, Dale W. & Wilcoxen, Peter J., 1993. "Reducing US carbon emissions: an econometric general equilibrium assessment," Resource and Energy Economics, Elsevier, vol. 15(1), pages 7-25, March. [Downloadable!] (restricted)
  14. Parry, Ian & Bento, Antonio, 1999. "Tax deductions, environmental policy, and the"double dividend"hypothesis," Policy Research Working Paper Series 2119, The World Bank. [Downloadable!]
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  15. Parry, Ian W. H. & Williams, Roberton III & Goulder, Lawrence H., 1999. "When Can Carbon Abatement Policies Increase Welfare? The Fundamental Role of Distorted Factor Markets," Journal of Environmental Economics and Management, Elsevier, vol. 37(1), pages 52-84, January. [Downloadable!] (restricted)
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  16. Parry, Ian W. H., 1997. "Environmental taxes and quotas in the presence of distorting taxes in factor markets," Resource and Energy Economics, Elsevier, vol. 19(3), pages 203-220, August. [Downloadable!] (restricted)
  17. James M. Poterba & Lawrence H. Summers, 1985. "The Economic Effects of Dividend Taxation," NBER Working Papers 1353, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  18. Goulder, Lawrence H. & Thalmann, Philippe, 1993. "Approaches to efficient capital taxation : Leveling the playing field vs. living by the golden rule," Journal of Public Economics, Elsevier, vol. 50(2), pages 169-196, February. [Downloadable!] (restricted)
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  19. Lawrence H. Goulder, 1994. "Energy Taxes: Traditional Efficiency Effects and Environmental Implications," NBER Chapters, in: Tax Policy and the Economy, Volume 8, pages 105-158 National Bureau of Economic Research, Inc. [Downloadable!]
  20. Parry Ian W. H., 1995. "Pollution Taxes and Revenue Recycling," Journal of Environmental Economics and Management, Elsevier, vol. 29(3), pages S64-S77, November. [Downloadable!] (restricted)
  21. Herman Vollebergh & Jan Vries & Paul Koutstaal, 1997. "Hybrid carbon incentive mechanisms and political acceptability," Environmental & Resource Economics, European Association of Environmental and Resource Economists, vol. 9(1), pages 43-63, January. [Downloadable!] (restricted)
  22. 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. [Downloadable!]
  23. Jorgenson, D.W. & Slesnick, D. & Wilcoxen, P.J., 1992. "Carbon Taxes and Economic Welfare," Harvard Institute of Economic Research Working Papers 1589, Harvard - Institute of Economic Research.
  24. Goulder Lawrence H., 1995. "Effects of Carbon Taxes in an Economy with Prior Tax Distortions: An Intertemporal General Equilibrium Analysis," Journal of Environmental Economics and Management, Elsevier, vol. 29(3), pages 271-297, November. [Downloadable!] (restricted)
  25. 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. [Downloadable!] (restricted)
  26. James M. Poterba, 1991. "Tax Policy to Combat Global Warming: On Designing a Carbon Tax," NBER Working Papers 3649, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  27. 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. [Downloadable!] (restricted)
  28. de Bovenberg, A Lans & Mooij, Ruud A, 1994. "Environmental Levies and Distortionary Taxation," American Economic Review, American Economic Association, vol. 84(4), pages 1085-89, September. [Downloadable!] (restricted)
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(explanations, Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.)

  1. Geir H. Bjertnæs and Taran Fæhn, 2004. "Energy Taxation in a Small, Open Economy: Efficiency Gains under Political Restraints," Discussion Papers 387, Research Department of Statistics Norway. [Downloadable!]
  2. Gilbert E. Metcalf, 2003. "Pollution Taxes in a Second-Best World," Discussion Papers Series, Department of Economics, Tufts University 0316, Department of Economics, Tufts University. [Downloadable!]
  3. Lawrence H. Goulder & William A. Pizer, 2006. "The Economics of Climate Change," NBER Working Papers 11923, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
    Other versions:
  4. Burtraw, Dallas & Kruger, Joseph & Zetterberg, Lars & Åhman, Markus, 2005. "The Ten-Year Rule: Allocation of Emission Allowances in the EU Emission Trading System," Discussion Papers dp-05-30, Resources For the Future. [Downloadable!]
  5. Parry, Ian, 2003. "Fiscal Interactions and the Case for Carbon Taxes over Grandfathered Carbon Permits," Discussion Papers dp-03-46, Resources For the Future. [Downloadable!]
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  6. Herman Vollebergh, 2004. "Lessons from the Polder: Is Dutch CO2-Taxation Optimal?," Working Papers 2004.6, Fondazione Eni Enrico Mattei. [Downloadable!]
  7. Goulder, Lawrence, 2002. "Mitigating the Adverse Impacts of CO2 Abatement Policies on Energy-Intensive Industries," Discussion Papers dp-02-22, Resources For the Future. [Downloadable!]
  8. Geir H. Bjertnæs, 2005. "Avoiding Adverse Employment Effects from Energy Taxation: What does it cost?," Discussion Papers 432, Research Department of Statistics Norway. [Downloadable!]
  9. Bovenberg, A.L. & Goulder, L.H. & Gurney, D.J., 2003. "Efficiency costs of meeting industry-distributional constraints under environmental permits and taxes," Discussion Paper 86, Tilburg University, Center for Economic Research. [Downloadable!]
    Other versions:
  10. Stefan Weishaar, 2007. "CO2 emission allowance allocation mechanisms, allocative efficiency and the environment: a static and dynamic perspective," European Journal of Law and Economics, Springer, vol. 24(1), pages 29-70, August. [Downloadable!] (restricted)
  11. Don Fullerton & Gilbert E. Metcalf, 2002. "Cap and Trade Policies in the Presence of Monopoly and Distortionary Taxation," NBER Working Papers 8901, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  12. Fischer, Carolyn & Fox, Alan, 2004. "Output-Based Allocations of Emissions Permits: Efficiency and Distributional Effects in a General Equilibrium Setting with Taxes and Trade," Discussion Papers dp-04-37, Resources For the Future. [Downloadable!]
  13. Burtraw, Dallas & Palmer, Karen & Bharvirkar, Ranjit & Paul, Anthony, 2002. "The Effect on Asset Values of the Allocation of Carbon Dioxide Emission Allowances," Discussion Papers dp-02-15-, Resources For the Future. [Downloadable!]
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  14. John C. V. Pezzey, 2002. "EmissionTaxes and Tradable Permits: A Comparison of views on Long Run Efficiency," Economics and Environment Network Working Papers 0210, Australian National University, Economics and Environment Network. [Downloadable!]
  15. Burtraw, Dallas & Palmer, Karen & Kahn, Daniel, 2005. "CO2 Allowance Allocation in the Regional Greenhouse Gas Initiative and the Effect on Electricity Investors," Discussion Papers dp-05-55, Resources For the Future. [Downloadable!]
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  16. Parry, Ian, 2003. "Are Emissions Permits Regressive?," Discussion Papers dp-03-21, Resources For the Future. [Downloadable!]
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