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Taxes and Trading versus Intensity Standards: Second-Best Environmental Policies with Incomplete Regulation (Leakage) or Market Power

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  • Stephen P. Holland

Abstract

This paper investigates whether an emissions tax (equivalent to an emissions cap) maximizes social welfare (defined as the sum of consumer and producer surplus) in the presence of incomplete regulation (leakage) or market power by analyzing an intensity standard regulating emissions per unit of output. With no other market failures, an intensity standard indeed yields lower welfare, although combining it with a consumption tax eliminates this discrepancy. For incomplete regulation, I show that under certain conditions an intensity standard can yield higher welfare than any emissions tax (including the optimal emissions tax). This result persists even with the addition of a consumption tax, which ameliorates output distortions and can sometimes help the intensity standard attain the first best (when an emissions tax/consumption tax combination cannot). Comparing intensity standards to output-based updating shows that the latter yields higher welfare because of its additional flexibility. Finally, I show that with market power an intensity standard can yield higher welfare than the optimal emissions tax. The intuition of these results is relatively straightforward. The weakness of an intensity standard is that it relies more on substitution effects than output effects to reduce emissions. With incomplete regulation or market power, this disadvantage may be helpful since leakage may offset gains from reducing output and since market power already inefficiently reduces output.

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  • Stephen P. Holland, 2009. "Taxes and Trading versus Intensity Standards: Second-Best Environmental Policies with Incomplete Regulation (Leakage) or Market Power," NBER Working Papers 15262, National Bureau of Economic Research, Inc.
  • Handle: RePEc:nbr:nberwo:15262
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    References listed on IDEAS

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    Cited by:

    1. Li, Zhe & Sun, Jianfei, 2015. "Emission taxes and standards in a general equilibrium with entry and exit," Journal of Economic Dynamics and Control, Elsevier, vol. 61(C), pages 34-60.
    2. Tombe, Trevor & Winter, Jennifer, 2015. "Environmental policy and misallocation: The productivity effect of intensity standards," Journal of Environmental Economics and Management, Elsevier, vol. 72(C), pages 137-163.
    3. Copeland, Brian R., 2012. "International trade and green growth," Policy Research Working Paper Series 6235, The World Bank.
    4. Kathy Baylis & Don Fullerton & Daniel H. Karney, 2014. "Negative Leakage," Journal of the Association of Environmental and Resource Economists, University of Chicago Press, vol. 1(1), pages 51-73.
    5. Stephen P. Holland, 2011. "Spillovers from Climate Policy to Other Pollutants," NBER Chapters,in: The Design and Implementation of U.S. Climate Policy, pages 79-90 National Bureau of Economic Research, Inc.
    6. Stephen P. Holland & Jonathan E. Hughes & Christopher R. Knittel & Nathan C. Parker, 2015. "Some Inconvenient Truths about Climate Change Policy: The Distributional Impacts of Transportation Policies," The Review of Economics and Statistics, MIT Press, vol. 97(5), pages 1052-1069, December.
    7. Holland, Stephen P., 2012. "Emissions taxes versus intensity standards: Second-best environmental policies with incomplete regulation," Journal of Environmental Economics and Management, Elsevier, vol. 63(3), pages 375-387.
    8. Gori, Giuseppe Francesco & Lambertini, Luca, 2013. "Trade liberalisation between asymmetric countries with environmentally concerned consumers," Regional Science and Urban Economics, Elsevier, vol. 43(4), pages 549-560.
    9. Rubin, Jonathan & Leiby, Paul N., 2013. "Tradable credits system design and cost savings for a national low carbon fuel standard for road transport," Energy Policy, Elsevier, vol. 56(C), pages 16-28.
    10. Derek Lemoine, 2017. "Escape from Third-Best: Rating Emissions for Intensity Standards," Environmental & Resource Economics, Springer;European Association of Environmental and Resource Economists, vol. 67(4), pages 789-821, August.
    11. Stephen P. Holland, 2010. "Spillovers from Climate Policy," NBER Working Papers 16158, National Bureau of Economic Research, Inc.

    More about this item

    JEL classification:

    • H23 - Public Economics - - Taxation, Subsidies, and Revenue - - - Externalities; Redistributive Effects; Environmental Taxes and Subsidies
    • Q40 - Agricultural and Natural Resource Economics; Environmental and Ecological Economics - - Energy - - - General
    • Q50 - Agricultural and Natural Resource Economics; Environmental and Ecological Economics - - Environmental Economics - - - General

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