Emission Tax or Standard? The Role of Productivity Dispersion

When a society wants to control aggregate emission under a certain target level, is it more desirable to impose a tax or a regulatory standard on emission? To answer this question, we explore a model where plants are heterogeneous in productivity and monopolistically competitive in the production of a set of varieties of (dirty-) goods whose by-product is emission. The main result is that the standard yields higher welfare than the tax if and only if productivity dispersion is small and the monopoly power in the dirty-goods sector is strong. In the process of obtaining this result, we find that, if the plants have no access to an abatement technology, then the tax dominates the standard unambiguously. When the plants do have access to an abatement technology, there can be less price distortion under the standard than under the tax, in which case the standard can yield higher welfare. These results illustrate that productivity dispersion is important for evaluating market-based environmental policies relative to non-market based policies.