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taxesadditive - Taxes versus quotas for a stock pollutant1...

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October 16, 2001 Taxes versus quotas for a stock pollutant 1 by Michael Hoel 2 and Larry Karp 3 Abstract We compare the effects of taxes and quotas for an environmental problem in which the regulator and polluter have asymmetric information about abatement costs, and the environmental damage depends on the stock of pollution. We thus extend, to a dynamic framework, previous studies in which environmental damages depend on the flow of pollution. As with the static analysis, an increase in the slope of the marginal abatement cost curve, or a decrease in the slope of the marginal damage curve, favors taxes. In addition, in the dynamic model, an increase in the discount rate or the stock decay rate favor the use of taxes. Taxes certainly dominate quotas if the length of a period during which decisions are constant is sufficiently small. An empirical illustration suggests that taxes dominate quotas for the control of greenhouse gasses. Keywords: Pollution control, asymmetric information, taxes and quotas, stochastic control JEL Classification numbers: H21, Q28 1 We would like to thank Atle Seierstad and Jinhua Zhao for their comments on an earlier version of this model, without implicating them in any remaining errors. We thank Maureen Cropper and Todd Sandler for suggestions on data, and Steve Warmerdam for research assistance. 2 Univ. of Oslo/ P.O. Box 1095 Blindern/ N-0317 OSLO / email: [email protected] . 3 Department of Agriculture and Resource Economics/ 207 Giannini Hall/ Berkeley CA 94720 email: [email protected]
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1 1. Introduction Asymmetric information plays an important role in environmental regulation when the polluter knows more than the regulator about the abatement cost function. In this situation, the first-best optimum can seldom be reached by using emission taxes or quotas. The first-best optimum equates the marginal abatement costs of the pollutants and the marginal environmental damage. Weitzman (1974) compared the expected payoff, under asymmetric information, for taxes and quotas. He assumed linear marginal costs, uncertainty only about the level of the marginal cost curves (not their slopes) and no correlation between the uncertainty of the abatement cost and the environmental cost. Under these assumptions, an emissions tax dominates a quota if and only if the marginal abatement cost curve is steeper than the marginal environmental cost curve. Subsequent contributions to this topic fall into two categories: (a) modifying the assumptions in Weitzman's analysis 1 , and (b) considering policy tools other than an emission tax and a direct specification of the emission level 2 . More complex policies can reduce the potential loss in social welfare associated with asymmetric information about abatement costs. However, in practice, policy-makers have not used these more sophisticated methods of environmental regulation.
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