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Efficiency Costs of Meeting Industry-Distributional Constraints under Environmental Permits and Taxes

Author

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  • A.L. Bovenberg
  • Lawrence H. Goulder
  • Derek J. Gurney

Abstract

A politically realistic approach to environmental policy seems to require avoiding significant profit-losses in major pollution-related industries. The government can avoid such losses by freely allocating some emissions permits or by exempting some inframarginal emissions from a pollution tax. However, preventing profit-losses in this way involves an efficiency cost because it compels the government to forego especially efficient sources of revenue and to rely more heavily on ordinary, distortionary taxes. Using analytically and numerically solved equilibrium models, we analyze these efficiency costs. We find that when the required amount of abatement is small, the efficiency cost implied by the profits-constraint dwarfs the other efficiency costs of pollution-control. When the abatement requirement becomes more extensive, the cost of this constraint diminishes relative to the other efficiency costs. We also calculate and analyze the determinants of the gross compensation ratio' the share of pollution permits that must be freely allocated to prevent profit-losses in the targeted industries. Numerical simulations of sulfur dioxide pollution-control suggest that the Bush Administration's Clear Skies Initiative would exceed this ratio, freely allocating more permits than necessary to preserve profits.

Suggested Citation

  • A.L. Bovenberg & Lawrence H. Goulder & Derek J. Gurney, 2003. "Efficiency Costs of Meeting Industry-Distributional Constraints under Environmental Permits and Taxes," NBER Working Papers 10059, National Bureau of Economic Research, Inc.
  • Handle: RePEc:nbr:nberwo:10059
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    References listed on IDEAS

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    1. Goulder, Lawrence H. & Parry, Ian W. H. & Williams III, Roberton C. & Burtraw, Dallas, 1999. "The cost-effectiveness of alternative instruments for environmental protection in a second-best setting," Journal of Public Economics, Elsevier, vol. 72(3), pages 329-360, June.
    2. Parry Ian W. H., 1995. "Pollution Taxes and Revenue Recycling," Journal of Environmental Economics and Management, Elsevier, vol. 29(3), pages 64-77, November.
    3. Ian W.H. Parry & Wallace E. Oates, 2000. "Policy analysis in the presence of distorting taxes," Journal of Policy Analysis and Management, John Wiley & Sons, Ltd., vol. 19(4), pages 603-613.
    4. Spencer Banzhaf, H. & Burtraw, Dallas & Palmer, Karen, 2004. "Efficient emission fees in the US electricity sector," Resource and Energy Economics, Elsevier, vol. 26(3), pages 317-341, September.
    5. Burtraw, Dallas & Palmer, Karen L. & Bharvirkar, Ranjit & Paul, Anthony, 2002. "The Effect on Asset Values of the Allocation of Carbon Dioxide Emission Allowances," Discussion Papers 10705, Resources for the Future.
    6. Robert Chirinko & Steven M. Fazzari & Andrew P. Meyer, 2002. "That Elusive Elasticity: A Long-panel Approach to Estimating the Price Sensitivity of Business Capital," Emory Economics 0202, Department of Economics, Emory University (Atlanta).
    7. Lawrence Goulder, 1995. "Environmental taxation and the double dividend: A reader's guide," International Tax and Public Finance, Springer;International Institute of Public Finance, vol. 2(2), pages 157-183, August.
    8. Burtraw, Dallas & Palmer, Karen & Bharvirkar, Ranjit & Paul, Anthony, 2002. "The Effect on Asset Values of the Allocation of Carbon Dioxide Emission Allowances," The Electricity Journal, Elsevier, vol. 15(5), pages 51-62, June.
    9. Farrow, Scott, 1999. "The duality of taxes and tradable permits: A survey with applications in Central and Eastern Europe," Environment and Development Economics, Cambridge University Press, vol. 4(04), pages 519-535, October.
    10. Lawrence H. Goulder & Ian W. H. Parry & Dallas Burtraw, 1996. "Revenue-Raising vs. Other Approaches to Environmental Protection: The Critical Significance of Pre-Existing Tax Distortions," NBER Working Papers 5641, National Bureau of Economic Research, Inc.
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    More about this item

    JEL classification:

    • H22 - Public Economics - - Taxation, Subsidies, and Revenue - - - Incidence
    • H23 - Public Economics - - Taxation, Subsidies, and Revenue - - - Externalities; Redistributive Effects; Environmental Taxes and Subsidies

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