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Innovation under taxes versus permits: how a commonly made assumption leads to misleading policy recommendations

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  • GERMAIN, Marc
  • VAN STEENBERGHE, Vincent

Abstract

The literature on the impact of economic instruments (typically taxes and tradable permits) on the level of innovation is usually based on the assumption that innovation reduces the slope of the marginal abatement cost curve. This assumption, which usually leads to the conclusion that taxes induce higher levels of innovation than tradable permits, is however never motivated. In this short article, we analyse the assumption by introducing innovation in the production function of a polluting firm and by showing how it affects the corresponding marginal abatement cost curve. We show that the slope of the marginal abatement cost curve does not necessarily decrease with the level of innovation. As a consequence, previous analyses lead to misleading policy recommendations.

Suggested Citation

  • GERMAIN, Marc & VAN STEENBERGHE, Vincent, 2005. "Innovation under taxes versus permits: how a commonly made assumption leads to misleading policy recommendations," CORE Discussion Papers 2005076, Universit√© catholique de Louvain, Center for Operations Research and Econometrics (CORE).
  • Handle: RePEc:cor:louvco:2005076
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    File URL: https://uclouvain.be/en/research-institutes/immaq/core/dp-2005.html
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    References listed on IDEAS

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    1. Jung, Chulho & Krutilla, Kerry & Boyd, Roy, 1996. "Incentives for Advanced Pollution Abatement Technology at the Industry Level: An Evaluation of Policy Alternatives," Journal of Environmental Economics and Management, Elsevier, vol. 30(1), pages 95-111, January.
    2. Fischer, Carolyn & Parry, Ian W. H. & Pizer, William A., 2003. "Instrument choice for environmental protection when technological innovation is endogenous," Journal of Environmental Economics and Management, Elsevier, vol. 45(3), pages 523-545, May.
    3. Goulder, Lawrence H. & Mathai, Koshy, 2000. "Optimal CO2 Abatement in the Presence of Induced Technological Change," Journal of Environmental Economics and Management, Elsevier, vol. 39(1), pages 1-38, January.
    4. McKitrick, Ross, 1999. "A Derivation of the Marginal Abatement Cost Curve," Journal of Environmental Economics and Management, Elsevier, vol. 37(3), pages 306-314, May.
    5. Milliman, Scott R. & Prince, Raymond, 1989. "Firm incentives to promote technological change in pollution control," Journal of Environmental Economics and Management, Elsevier, vol. 17(3), pages 247-265, November.
    6. Downing, Paul B. & White, Lawrence J., 1986. "Innovation in pollution control," Journal of Environmental Economics and Management, Elsevier, vol. 13(1), pages 18-29, March.
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    Cited by:

    1. Rabah Amir & Marc Germain & Vincent Van Steenberghe, 2008. "On the Impact of Innovation on the Marginal Abatement Cost Curve," Journal of Public Economic Theory, Association for Public Economic Theory, vol. 10(6), pages 985-1010, December.

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