Pollution permits, green taxes, and the environmental poverty trap

We compare the steady states and transition dynamics under pollution permits and under green taxes in an overlapping generations model with endogenous longevity. Multiple steady states can emerge under pollution permits. One nontrivial steady state is an environmental poverty trap (EPT). This steady state is characterized by low capital and high pollution. An economy operating in the neighborhood will gravitate toward this steady state in the long run. The other nontrivial steady state featuring high capital and low pollution is desirable. A saddle path may lead to this desirable steady state. In contrast, the steady state under green taxes is unique and locally stable. We also design policies that prevent an economy from falling into the EPT under pollution permits. Our conclusion is that an economy can continue to consider pollution permits as an efficient environmental regulation but proceed with caution given the possibility of being drawn into an EPT.