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Suggested Subsidies are Sub-optimal Unless Combined with an Output Tax

Author

Listed:
  • Fullerton Don

    () (University of Texas at Austin)

  • Mohr Robert D.

    () (University of New Hampshire)

Abstract

Because of difficulties measuring pollution, many prior papers suggest a subsidy to some observable method of reducing pollution. We take three such papers as examples, and we extend each of them to show how welfare under the suggested subsidy can be increased by the addition of an output tax. While the suggested subsidy reduces damage per unit of output, it also decreases the firm's cost of production and the equilibrium break-even price. It might therefore increase output – unless combined with an output tax. While this general point has appeared in prior literature, it has been overlooked in specific applications. We illustrate the applicability of a tax-subsidy combination in three very different models of different environmental problems. Using one example, we show that a properly-constructed subsidy-tax combination is equivalent to a Pigovian tax. Another example is a computational model, extended here to show that the policy combination can yield a welfare gain that is more than three times the gain from using the subsidy alone. The third example is a theoretical model, used to show that the subsidy alone increases production and thus could increase total pollution. An additional output tax offsets this increase in production.

Suggested Citation

  • Fullerton Don & Mohr Robert D., 2003. "Suggested Subsidies are Sub-optimal Unless Combined with an Output Tax," The B.E. Journal of Economic Analysis & Policy, De Gruyter, vol. 2(1), pages 1-22, January.
  • Handle: RePEc:bpj:bejeap:v:contributions.2:y:2003:i:1:n:1
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    References listed on IDEAS

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    1. Stranlund, John K., 1997. "Public Technological Aid to Support Compliance to Environmental Standards," Journal of Environmental Economics and Management, Elsevier, vol. 34(3), pages 228-239, November.
    2. Isaac Ehrlich, 1974. "Participation in Illegitimate Activities: An Economic Analysis," NBER Chapters,in: Essays in the Economics of Crime and Punishment, pages 68-134 National Bureau of Economic Research, Inc.
    3. Deacon Robert T., 1995. "Assessing the Relationship between Government Policy and Deforestation," Journal of Environmental Economics and Management, Elsevier, vol. 28(1), pages 1-18, January.
    4. Sullivan, Arthur M., 1987. "Policy options for toxics disposal: Laissez-faire, subsidization, and enforcement," Journal of Environmental Economics and Management, Elsevier, vol. 14(1), pages 58-71, March.
    5. Fullerton Don & West Sarah E, 2010. "Tax and Subsidy Combinations for the Control of Car Pollution," The B.E. Journal of Economic Analysis & Policy, De Gruyter, vol. 10(1), pages 1-33, February.
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    Citations

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    Cited by:

    1. Mohr, Robert D., 2006. "Environmental performance standards and the adoption of technology," Ecological Economics, Elsevier, vol. 58(2), pages 238-248, June.
    2. Borger, Bruno De, 2011. "Optimal congestion taxes in a time allocation model," Transportation Research Part B: Methodological, Elsevier, vol. 45(1), pages 79-95, January.
    3. Arguedas, Carmen & van Soest, Daan P., 2009. "On reducing the windfall profits in environmental subsidy programs," Journal of Environmental Economics and Management, Elsevier, vol. 58(2), pages 192-205, September.
    4. Holland, Stephen P., 2012. "Emissions taxes versus intensity standards: Second-best environmental policies with incomplete regulation," Journal of Environmental Economics and Management, Elsevier, vol. 63(3), pages 375-387.
    5. Hagem, Cathrine & Hoel, Michael & Holtsmark, Bjart & Sterner, Thomas, 2015. "Refunding Emissions Payments," Discussion Papers dp-15-05, Resources For the Future.
    6. Maia David & Bernard Sinclair-Desgagné, 2006. "Revisiting the Environmental Subsidy in the Presence of an Eco-Industry," Working Papers 2006/04, INRA, Economie Publique.
    7. Mazumder, Diya B., 2014. "Biofuel subsidies versus the gas tax: The carrot or the stick?," Energy Economics, Elsevier, vol. 44(C), pages 361-374.
    8. Stephen P. Holland, 2009. "Taxes and Trading versus Intensity Standards: Second-Best Environmental Policies with Incomplete Regulation (Leakage) or Market Power," NBER Working Papers 15262, National Bureau of Economic Research, Inc.

    More about this item

    JEL classification:

    • H23 - Public Economics - - Taxation, Subsidies, and Revenue - - - Externalities; Redistributive Effects; Environmental Taxes and Subsidies
    • H25 - Public Economics - - Taxation, Subsidies, and Revenue - - - Business Taxes and Subsidies

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