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Robust Optimal Taxation and Environmental Externalities

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  • Li, Xin

    (Rice University)

  • Narajabad, Borghan

    (Rice University)

  • Temzelides, Ted

    (Rice University)

Abstract

We study optimal taxation in a dynamic stochastic general equilibrium model where agents are concerned about model uncertainty regarding climate change. An externality from green-house gas emissions adversely affects the economy's capital stock. We assume that the mapping from climate change to damages is subject to uncertainty, and we adapt and use techniques from robust control theory in order to study efficiency and optimal policy. We obtain a sharp analytical solution for the implied environmental externality and we characterize dynamic optimal taxation. A small increase in the concern about model uncertainty can cause a significant drop in optimal energy extraction. The optimal tax which restores the social optimal allocation is Pigouvian. Under more general assumptions, we develop a recursive method and solve the model computationally. We find that the introduction of uncertainty matters qualitatively and quantitatively. We study optimal GDP growth in the presence and in the absence of concerns about uncertainty and find that these can lead to different conclusions.

Suggested Citation

  • Li, Xin & Narajabad, Borghan & Temzelides, Ted, 2012. "Robust Optimal Taxation and Environmental Externalities," Working Papers 14-006, Rice University, Department of Economics.
    • Handle: RePEc:ecl:riceco:14-006
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    File URL: http://economics.rice.edu/rise/working-papers/robust-optimal-taxation-and-environmental-externalities
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    Cited by:

    1. Shrestha, Manish & Piman, Thanapon & Grünbühel, Clemens, 2021. "Prioritizing key biodiversity areas for conservation based on threats and ecosystem services using participatory and GIS-based modeling in Chindwin River Basin, Myanmar," Ecosystem Services, Elsevier, vol. 48(C).
    2. Lockwood, Benjamin B. & Weinzierl, Matthew, 2016. "Positive and normative judgments implicit in U.S. tax policy, and the costs of unequal growth and recessions," Journal of Monetary Economics, Elsevier, vol. 77(C), pages 30-47.

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