Carbon abatement in the fuel market with biofuels: Implications for second best policies

A carbon tax on fuel would penalize carbon intensive fuels like gasoline and shift fuel consumption to less carbon intensive alternatives like biofuels. Since biofuel production competes for land with agricultural production, a carbon tax could increase land rents and raise food prices. This paper analyzes the welfare effect of a carbon tax on fuel consisting of gasoline and biofuel in the presence of a labor tax, with and without a biofuel subsidy. The market impacts of a carbon tax are also compared with that of a subsidy. Findings show that if a carbon tax increases biofuel demand, the tax interaction effect due to higher fuel prices is exacerbated by higher land rent and food prices and greater erosion of the carbon tax base. Thus, the second best optimal carbon tax for fuel is lower with biofuel in the fuel mix, especially if biofuel is subsidized.     

Optimal policy instruments for externality-producing durable goods under present bias

When consumers exhibit present bias, the standard solution to market failures caused by externalities—Pigouvian pricing—is suboptimal. I investigate policies aimed at externalities for present-biased consumers. Optimal policy includes an instrument to correct the externality and an instrument to correct the present bias. Either instrument can be an incentive-based policy (e.g. a tax on fuel economy) or a command-and-control policy (e.g. a fuel economy mandate). Under consumer heterogeneity, a command-and-control policy may dominate an incentive-based policy. Calibrated to the US automobile market, simulation results suggest that the second-best gasoline tax is 3–30% higher than marginal external damages. The optimal price policy includes a gasoline tax set about equal to marginal external damages and a fuel economy tax that increases the price of an average non-hybrid car by about $550–$2200 relative to the price of an average hybrid car.     

Estimates from a consumer demand system: implications for the incidence of environmental taxes

Most studies suggest that environmental taxes are regressive, making them less attractive policy options. We consider the distributional effects of a gasoline tax increase using four incidence measures and under three scenarios for gas tax revenue use. To incorporate behavioral responses we use Consumer Expenditure Survey data to estimate a consumer demand system that includes gasoline, other goods, and leisure. Our estimates confirm that when revenues are not recycled, a gasoline tax is regressive. Use of incidence measures that ignore demand responses, however, will substantially overstate this regressivity. In contrast, the differences between the equivalent variation and easier-to-implement consumer surplus measures are relatively small. In addition, our results suggest that using the additional gas tax revenue to fund labor tax cuts makes the policy substantially less regressive while using the revenue to fund lump-sum transfers actually makes it progressive.     

Strategic climate policy with offsets and incomplete abatement: Carbon taxes versus cap-and-trade

This paper provides a first analysis of a “policy bloc” of fossil fuel importers which implements an optimal climate policy, faces a (non-policy) fringe of other fuel importers, and an exporter bloc, and purchases offset from the fringe. We compare a carbon tax and a cap-and-trade scheme for the policy bloc, in either case accompanied by an efficient offset mechanism for reducing emissions in the fringe. The policy bloc is shown to prefer a tax over a cap, since only a tax reduces the fuel export price and by more when the policy bloc is larger. Offsets are also more favorable to the policy bloc under a tax than under a cap. The optimal offset price under a carbon tax is below the tax rate, while under a cap and free quota trading the offset price must equal the quota price. The domestic carbon and offset prices are both higher under a tax than under a cap when the policy bloc is small. When the policy bloc is larger, the offset price can be higher under a cap. Fringe countries gain by mitigation in the policy bloc, more under a carbon tax since the fuel import price is lower.     

The higher price of cleaner fuels: Market power in the rail transport of fuel ethanol

This paper provides evidence of market power in the transportation of ethanol used in reformulated gasoline and alternative transportation fuels. I estimate a reduced form model for railroad route-level prices. My identification strategy instruments for railroad entry, controls for selection and explicitly models capacity constraints. A detailed understanding of this industry is important because U.S. environmental policies seek to substantially expand ethanol use. Evidence of market power may alter the types of policies pursued by lawmakers. I find that ethanol shipment prices are lower for more competitive routes. I also find evidence that railroads price discriminate based on environmental regulation at route destinations. Monopolist prices for shipments to carbon monoxide non-attainment areas are 3% higher than shipments to other destinations. This price premium falls sharply with increased competition. This suggests a perverse result where environmental regulation increases the price of a clean input.     

Carbon Payments and Low‐Cost Conservation

Abstract: A price on carbon is expected to generate demand for carbon offset schemes. This demand could drive investment in tree‐based monocultures that provide higher carbon yields than diverse plantings of native tree and shrub species, which sequester less carbon but provide greater variation in vegetation structure and composition. Economic instruments such as species conservation banking, the creation and trading of credits that represent biological‐diversity values on private land, could close the financial gap between monocultures and more diverse plantings by providing payments to individuals who plant diverse species in locations that contribute to conservation and restoration goals. We studied a highly modified agricultural system in southern Australia that is typical of many temperate agriculture zones globally (i.e., has a high proportion of endangered species, high levels of habitat fragmentation, and presence of non‐native species). We quantified the economic returns from agriculture and from carbon plantings (monoculture and mixed tree and shrubs) under six carbon‐price scenarios. We also identified high‐priority locations for restoration of cleared landscapes with mixed tree and shrub carbon plantings. Depending on the price of carbon, direct annual payments to landowners of AU$7/ha/year to $125/ha/year (US$6–120/ha/year) may be sufficient to augment economic returns from a carbon market and encourage tree plantings that contribute more to the restoration of natural systems and endangered species habitats than monocultures. Thus, areas of high priority for conservation and restoration may be restored relatively cheaply in the presence of a carbon market. Overall, however, less carbon is sequestered by mixed native tree and shrub plantings.     

Market equilibrium and welfare effects of a fuel tax in China: The impact of consumers' response through driving patterns

We investigate the market equilibrium and welfare effects of a fuel tax in China relative to an alternative policy instrument that rations the number of new automobile sales through auctioned quotas. Unlike those of previous studies, our modeling approach incorporates both household car purchase and utilization decisions, the latter of which have been ignored in previous studies on China's fuel tax. Ignoring this margin of choice will underestimate the fuel tax's ability to mitigate externalities. Using detailed household-level panel data and a fixed effects econometric specification, we estimate the fuel price elasticity of vehicle miles traveled is −0.59 on average. The results of the counterfactual analysis suggest that a 51% increase in tax-inclusive gasoline prices will reduce car sales by 24.9% but increase social welfare to a degree that depends on vehicles' lifetime. We find that compared to auctioned quotas, the fuel tax results in greater car sales but higher social welfare.     

Tax evasion and optimal environmental taxes

This paper introduces a new argument to the debate about the role of environmental taxes in modern tax systems. Some environmental taxes, particularly taxes on gasoline or electricity, are more difficult to evade than taxes on labor or income. When the tax base is shifted in a revenue-neutral manner toward these environmental taxes, the result is a net reduction in the amount of tax evasion. Using a carbon tax as a motivating example, the “tax evasion effect” is shown to sharply reduce the welfare cost of controlling emissions. A simple computable general equilibrium model suggests that the impact of considering tax evasion can be large: costs are lowered by 28% in the United States, by 89% in China, and by 97% in India. In countries with high levels of pre-existing tax evasion, a carbon tax will pay for itself through improvements in the efficiency of the tax system.     

Oil Exploration under Climate Treaties

In this paper we focus on how an international climate treaty will influence the exploration of oil in non-OPEC countries. We present a numerical intertemporal global equilibrium model for the fossil fuel markets. The international oil market is modelled with a cartel (OPEC) and a competitive fringe on the supply side, following a Nash–Cournot approach. An initial resource base for oil is given in the non-OPEC region. However, the resource base changes over time due to depletion, exploration, and discovery. When studying the effects of different climate treaties on oil exploration, two contrasting incentives apply. If an international carbon tax is introduced, the producer price of oil will drop compared to the reference case. This gives an incentive to reduce oil production and exploration. However, the oil price may increase less rapidly over time, which gives an incentive to expedite production and exploration. In fact, in the case of a rising carbon tax we find the last incentive to be the strongest, which means that an international climate treaty may increase oil exploration in non-OPEC countries for the coming decades and reduce OPEC's market share.     

Taxing overexploited open-access fisheries: the role of demand elasticity

The paper aims at identifying the effects exerted by a tax levy on an overexploited and previously unregulated fishery. The analysis is carried out by means of a dynamic model that includes fish stock and harvesting effort as state variables. Attention is focused on the role played by demand elasticity which is shown to affect both transients and equilibria.According to the analysis, a levy induces a contraction in effort, which is sharper in the short term. As a consequence, the fish population recovers and ultimately settles at a higher equilibrium level. Therefore, a larger amount of fish is caught in the long run and sold at a lower price than in the unregulated setting. The more inelastic the demand, the smaller both the equilibrium price for fish and the tax imposed.     

Fuel switching,gasoline price controls,and the leaded-unleaded gasoline price differential

The Environmental Protection Agency and others have opposed gasoline price decontrol, alleging a wider posted price differential between leaded and unleaded grades would result, inducing more motorists to switch illegally to leaded gasoline fouling catalytic converters and hence increasing air pollution. EPA's model must assume that only the unleaded price ceiling is binding. It is shown that the resulting excess demand is shifted to a close substitute: leaded gasoline. Hence, controls cause more consumption of leaded fuel in new cars (switching) and more pollution. Thus, decontrol would have a palliative effect, contrary to EPA's claim.     

Incomplete International Cooperation to Reduce CO2 Emissions: The Case of Price Discrimination

This paper analyzes the effect of introducing a fuel tax in some countries, but not all, when the world fuel market is monopolistic. Based on the observation that price discrimination becomes possible in these circumstances, it is shown that the fuel price in countries not levying the tax may increase, in contrast to common views.     

Clearing the air: The costs and consequences of higher CAFE standards and increased gasoline taxes

Concerns about energy security and climate change have sparked legislators’ interest in reducing gasoline consumption by increasing corporate average fuel-economy (CAFE) standards. Using an empirically rich simulation model and cost estimates for anticipated fuel-economy technologies, we estimate annual costs of reducing long-run gasoline consumption by 10% via a 3.8 miles per gallon increase in the standards, and the potential cost savings from allowing manufacturers to buy and sell fuel-economy credits. Maximum gasoline savings would be realized only after all existing vehicles were replaced, or 14 years in our model. A gasoline tax would produce greater immediate savings by encouraging people to drive less, and eventually to choose more-fuel-efficient vehicles. We demonstrate the advantage of a tax by comparing the cost of the higher CAFE standards over the first 14 years against the cost of a gasoline tax that would save the same amount of gasoline over that time.     

The welfare effects of fuel conservation policies in a dual-fuel car market: Evidence from India

We estimate a model of vehicle choice and kilometers driven to analyze the long-run impacts of fuel conservation policies in the Indian car market. We simulate the effects of petrol and diesel fuel taxes and a diesel car tax, taking into account their interactions with the pre-existing petrol fuel tax and car sales taxes. At levels sufficient to reduce total fuel consumption by 7%, the increased diesel and petrol fuel taxes both yield deadweight losses (net of externalities) of about 4 (2010) Rs./L. However, at levels sufficient to reduce total fuel consumption by 2%, the increased petrol fuel tax results in a deadweight loss per liter of fuel conserved that is greater than that caused by the diesel fuel tax. This reflects both the high pre-existing tax on petrol fuel and the high own-price elasticities of fuel demand in India. A tax on diesel cars that results in the same diesel market share as the large diesel fuel tax actually has a negative deadweight loss per liter of fuel conserved. The welfare effects of all three policy instruments are positive, once the external benefits of reducing fuel consumption are added to the excess burden of taxation.     

Pollution Haven and Corruption Paradise

In this paper, we present a simple theoretical extension from the Economic Geography literature to characterize the main features of pollution havens (lax environmental regulation, good market access to high-income countries and corruption opportunities). Using structural and reduced-form estimations, we find that pollution havens are not a “popular myth” for European firms, laxer environmental standards significantly explain the location choice of polluting affiliates. We analyze in depth the role of trade costs (using various bilateral and multilateral measures), a 1% increase in access to the European market from a pollution haven fosters relocation there by 0.1%. We also find that corruption lowers environmental standards, which strongly attract polluting firms: a 1% increase of corruption fuels relocation by 0.28%. We test the economic significance of these empirical findings via simulations. The protection of the European market (e.g., a carbon tax on imports) to stop relocations to pollution havens must be high (a decrease of the European market for Morocco and Tunisia equivalent to 13%) not to say prohibitive (31% for China).     

Do you not like Pigou, or do you not understand him? Tax aversion and revenue recycling in the lab

Tax-aversion reduces the likelihood that price rationing can be a politically viable tool for environmental protection. We examine the case of the classic Pigouvian tax to control a negative externality, and consider how recycling the revenues, labeling of the tax and information about its purpose affects the support for taxation. We test the support for taxation within a single-price market experiment, in which purchases by some buyers impose external costs on others. Observing behavior consistent with tax-aversion, we also find that recycling the revenues to more narrowly targeted groups seems to increase support for taxation. In the absence of narrow revenue recycling, labeling a Pigouvian instrument as a ‘tax’ may significantly lower the likelihood of voter support.     

Commercial fisheries under price uncertainty

The deterministic models applied in economics of fisheries are extended to comprise price uncertainty and risk aversion among the fishing units. It is proved that in the open-access fishery both the total fishing effort and the number of fishing units are reduced as the variance of the price increases; that the total fishing effort may be smaller in the open-access fishery than in the optimal fishery at a high variance; that only a fixed producer price system can create a first-best optimum, and that a tax on revenue is more efficient than both fishing unit quotas or tax on catch.     

Giving green to get green? Incentives and consumer adoption of hybrid vehicle technology

Federal, state, and local governments use a variety of incentives to induce consumer adoption of hybrid-electric vehicles. We study the relative efficacy of state sales tax waivers, income tax credits, and non-tax incentives and find that the type of tax incentive offered is as important as the generosity of the incentive. Conditional on value, sales tax waivers are associated with more than a ten-fold increase in hybrid sales relative to income tax credits. In addition, we examine how adoption varies with fuel prices. Rising gasoline prices are associated with greater hybrid vehicle sales, but this effect operates almost entirely through high fuel-economy vehicles. By comparing consumer response to sales tax waivers and estimated future fuel savings, we estimate an implicit discount rate of 14.6% on future fuel savings.     

Energy taxes and endogenous technological change

This paper studies the effects of a tax on energy use in a growth model where market structure is endogenous and jointly determined with the rate of technological change. Because this economy does not exhibit the scale effect (a positive relation between TFP growth and aggregate R&D), the tax has no effect on the steady-state growth rate. It has, however, important transitional effects that give rise to surprising results. Specifically, under the plausible assumption that energy demand is inelastic, there may exist a hump-shaped relation between the energy tax and welfare. This shape stems from the fact that the reallocation of resources from energy production to manufacturing triggers a temporary acceleration of TFP growth that generates a √-shaped time profile of consumption. If endogenous technological change raises consumption sufficiently fast and by a sufficient amount in the long run, and households are sufficiently patient, the tax raises welfare despite the fact that—in line with standard intuition—it lowers consumption in the short run.     

Redistribution and pollution taxes with non-linear Engel curves

This paper analyses optimal corrective taxation and optimal income redistribution. The Pigouvian pollution tax is higher if pollution damages disproportionally hurt the poor due to equity weighting of pollution damages. Moreover, under general utility functions, optimal pollution taxes should be set below the Pigouvian tax if the poor spend a disproportionate fraction of their income on polluting goods. However, if Engel curves are linear, optimal pollution taxes should follow the first-best rule for the Pigouvian corrective tax even if the government wants to redistribute income and the poor spend a disproportional part of their income on polluting goods. The often-used quasi-linear, CES and Stone-Geary utility functions all have linear Engel curves. If Engel curves are linear, and if pollution taxes are not optimised, Pareto-improving green tax reforms exist that move the pollution tax closer to the Pigouvian tax. Simulations demonstrate that optimal corrective taxes should be Pigouvian if the demand for polluting goods is derived from a LES demand system, but deviate from the Pigouvian taxes if demand for polluting goods demand is derived from a PIGLOG demand system.