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Should Carbon Taxes be Pre-Announced? On Irreversible Investment, Real Options and Carbon Taxes

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  • van Wijnbergen, Sweder

Abstract

Climate change and its two-way relation with economic activity is stochastic and so is therefore the optimal tax internalizing the climate externality. But with capital irreversibility a stochastic time path for carbon prices slows down the reallocation from brown to green sectors because waiting then acquires an option value. We show that it is optimal to pre-announce a time path for future carbon taxes, eliminating the option value of waiting at the cost of suboptimality of the pre-announced taxes at the time they apply. We analyse for how long carbon taxes should be pre-announced and which factors influence that timespan.

Suggested Citation

  • van Wijnbergen, Sweder, 2025. "Should Carbon Taxes be Pre-Announced? On Irreversible Investment, Real Options and Carbon Taxes," CEPR Discussion Papers 20438, C.E.P.R. Discussion Papers.
    • Handle: RePEc:cpr:ceprdp:20438
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    File URL: https://cepr.org/publications/DP20438
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    Keywords

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    JEL classification:

    • G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing
    • H2 - Public Economics - - Taxation, Subsidies, and Revenue
    • Q51 - Agricultural and Natural Resource Economics; Environmental and Ecological Economics - - Environmental Economics - - - Valuation of Environmental Effects
    • Q54 - Agricultural and Natural Resource Economics; Environmental and Ecological Economics - - Environmental Economics - - - Climate; Natural Disasters and their Management; Global Warming

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