Regional Effects of an Emissions-Reduction Policy in China: The Importance of the Government Financing Method

China is under considerable pressure to reduce its CO2 emissions and has given a public commitment to substantial cuts by 2020. Policy-makers are acutely aware of the possible adverse economic consequences of such cuts and an important part of this issue is the regional dimension – will policy to reduce pollution exacerbate the already large inter-regional disparities in China and, if so, will some policies be better than others? These issues have received relatively little attention in the literature. We contribute to knowledge of the economic environment in which policy choices must be made by exploring the regional economic effects of a variety of policies by which pollution might be reduced. We use a small theoretical two-region model designed to capture some of the salient features of the Chinese regions and the tax/expenditure system. We compare an emissions tax with an abatement subsidy and find them equivalent if a lump-sum profits tax/subsidy is available. We argue that in practice abatement subsidies are more likely to be financed by expenditure cuts or tax increases and go on to explore the effects of an abatement subsidy under a variety of financing assumption. Two general conclusions emerge from our results: (a) the effects of pollution control policies on regional disparities depend on how the disparities are measured, and (b) the government financing matters.