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taxesmultiplicative - Taxes and Quotas for a Stock...

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July 28, 2000 Taxes and Quotas for a Stock Pollutant with Multiplicative Uncertainty Michael Hoel and Larry Karp Abstract We compare taxes and quotas when fi rms and the regulator have asymmetric information about the slope of fi rms’ abatement costs. Damages are caused by a stock pollutant. We calibrate the model using cost and damage estimates of greenhouse gasses. Taxes dominate quotas, as with additive uncertainty. This model with multiplicative uncertainty allows us to compare expected stock levels under the two policies, and to investigate the importance of stock size and the magnitude of uncertainty on the policy ranking. Key Words: Pollution control, asymmetric information, taxes and quotas, stochastic control, global warming, multiplicative disturbances JEL Classi fi cation Numbers: H21, Q28 Giannini Foundation Working Paper 870. An earlier version of this paper was distributed as Nota di Lavoro 15.99, Fondazione Eni Enrico Mattei. We thank three referees for their comments, but claim responsibility for any remaining errors. Univ.of Oslo, PO Box 1095 Blindern, N-0317 OSLO Norway; email: [email protected] Corresponding Author. Department of Agriculture and Resource Economics, 207 Giannini Hall, Berke- ley CA 94720; email: [email protected]
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1 Introduction Most important pollutants persist in the environment for a non-negligible period. For these pollutants, the environmental damage at a point in time depends primarily on the existing stock, rather than the fl ow. The current fl ow changes future stocks and therefore a ff ects future damages, but in many cases the current fl ow does not contribute directly to current damages. For example, the danger of global warming (possibly) depends on stocks of greenhouse gasses. The fl ow of these gasses may also be associated with health costs, but their major social cost arises through the increased future stock of greenhouse gasses. When the fi rms that produce emissions have better information about abatement costs than do regulators, control of pollution becomes more di cult. The regulator needs to choose both the type of policy (e.g., a tax or quota) and the level of the policy. Asymmetry of information can occur regardless of whether environmental damages are associated with fl ows or stocks. A static model can be used to represent the problem of a regulator facing a fl ow pollutant, but a stock pollutant requires a dynamic model. Most of the theoretical literature on pollution control under asymmetric information has focused on fl ow pollutants. Here we contribute to the literature on the control of stock pollutants under asymmetric information about abatement costs. Many ingenious ways of controlling pollution under asymmetric information have been devised using principal-agent models. In practice, most regulations rely on either quantity restrictions (quotas) or taxes. An important literature, beginning with Weitzman (1974), compares social welfare under these two policies. Subsequent contributions that study the 1
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