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The Cost-Effectiveness of Alternative Instruments for Environmental Protection in a Second-Best Setting

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  • Burtraw, Dallas

    ()
    (Resources for the Future)

  • Parry, Ian

    ()
    (Resources for the Future)

  • Goulder, Lawrence
  • Williams III, Roberton

Abstract

This paper employs analytical and numerical general equilibrium models to examine the costs of achieving pollution reductions under a range of environmental policy instruments in a second-best setting with pre-existing factor taxes. We compare the costs and overall efficiency impacts of emissions taxes, emissions quotas, fuels taxes, performance standards, and mandated technologies, and explore how costs change with the magnitude of pre-existing taxes and the extent of pollution abatement. We find that the presence of distortionary taxes raises the costs of pollution abatement under each instrument relative to its costs in a first-best world. This extra cost is an increasing function of the magnitude of pre-existing tax rates. For plausible values of pre-existing tax rates and other parameters, the cost increase for all policies is substantial (35 percent or more). The impact of pre-existing taxes is particularly large for non-auctioned emissions quotas: here the cost increase can be several hundred percent. Earlier work on instrument choice has emphasized the potential reduction in compliance cost achievable by converting fixed emissions quotas into tradable emissions permits. Our results indicate that the regulator's decision whether to auction or grandfather emissions rights can have equally important cost impacts. Similarly, the choice as to how to recycle revenues from environmentally motivated taxes (whether to return the revenues in lump-sum fashion or via cuts in marginal tax rates) can be as important to cost as the decision whether the tax takes the form of an emissions tax or fuel tax, particularly when modest emissions reductions are involved. In both first- and second-best settings, the cost differences across instruments depend importantly on the extent of pollution abatement under consideration. Total abatement costs differ markedly at low levels of abatement. Strikingly, for all instruments except the fuel tax these costs converge to the same value as abatement levels approach 100 percent.

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Bibliographic Info

Paper provided by Resources For the Future in its series Discussion Papers with number dp-98-22.

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Date of creation: 01 Mar 1998
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Handle: RePEc:rff:dpaper:dp-98-22

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  1. Stavins, Robert & Jaffe, Adam & Newell, Richard, 1998. "The Induced Innovation Hypothesis and Energy-Saving Technological Change," Discussion Papers dp-98-12-rev, Resources For the Future.
  2. Roberton C. Williams, 2000. "Environmental Tax Interactions When Pollution Affects Health or Productivity," NBER Working Papers 8049, National Bureau of Economic Research, Inc.
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  4. 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.
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  1. > Environmental and Natural Resource Economics > Environmental Economics > Policy instruments
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