R&D Strategies of Polluting Firms Facing an Emissions Tax: Cost Reduction Versus Pollution Abatement

Firms’ efforts to reduce pollution emissions in their production processes are induced by market forces as well as governmental regulatory instruments. The market forces, which might induce firms to increase production to maximize profits, work at cross-purposes. One of the common solutions is that firms resort to R&D investment, which lowers production costs with greater pollution being an unwelcome by-product (the tax burden effect). Pollution abatement (PA) investment, which is another solution, focuses on reducing emissions, with no direct impacts on production costs. We evaluate whether R&D investment effectively plays a role in profit maximization depends on the tax burden effect. Besides, judging from a socio-economic perspective, the PA strategy is significantly superior to the R&D strategy when (pollution) damage cost parameters are medium or high. However, the reverse result holds when they are small. Our findings thus formally flesh out the implications of choosing R&D versus PA strategies in response to pollution control regulations.