On optimal audit mechanisms for environmental taxes

We consider the auditing problem of an environmental enforcement agency with fixed audit resources: How to decide which firms to audit after having observed the firms' taxable emissions reports. The goal of the agency is to implement the socially efficient emissions level. The audit mechanism is the agency's sole choice variable, while other variables such as the tax rate on emissions and the fine for non-compliance are determined by other governmental actors. The fines and budget of the agency are constrained in such a way that the common random audit mechanism fails to implement socially efficient emissions. Assuming perfect information among the firms, we derive an optimal audit mechanism capable of implementing the socially efficient emissions level. The optimal audit mechanism creates a contest exploiting the strategic interdependencies between the firms, where the probability of winning (not being audited) for each firm depends on costly efforts (their taxable emissions reports).     

Salience of carbon taxes in the gasoline market

We demonstrate that the carbon tax imposed by the Canadian province of British Columbia caused a decline in short-run gasoline demand that is significantly greater than would be expected from an equivalent increase in the market price of gasoline. That the carbon tax is more salient, or yields a larger change in demand than equivalent market price movements, is robust to a range of specifications. As a result of the large consumer response to the tax, we calculate that during its first four years, the tax reduced carbon dioxide emissions from gasoline consumption by 2.4 million tonnes.     

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.     

Multiple receptor ambient monitoring and firm compliance with environmental taxes under budget and target driven regulatory missions

We analyze the potential for an environmental monitoring agency under different regulatory missions to use multiple measures of ambient pollution levels to induce firm compliance via endogenously determined probabilistic firm-level inspections of polluting activities. Departing from previous analyses, we consider a framework where the regulator has multiple, rather than a single, measures of ambient pollution in a setting where many firms are subject to a self-reported emissions tax that is not perfectly enforceable. Under a budget-driven mission, we show that a regulator can fruitfully utilize the added information from multiple ambient monitoring receptors to induce improved environmental compliance through the creation of strategic interactions among firms. Additionally, our results provide new evidence on the relative efficiency of budget- vs. target-driven environmental enforcement missions.     

Cap-and-trade, taxes, and distributional conflict

Enacting market-based environmental regulation, such as emissions taxes and cap-and-trade programs, often create rents that are contested by agents. In this paper, we create a framework that compares social welfare from alternative market-based environmental policy instruments under the presence of rent seeking. We show that, contrary to the commonly held view, non-revenue-raising instruments (NRRIs) are in many cases preferable over revenue-raising instruments (RRIs). We find that the choice of instrument depends on the size of a potential revenue-recycling effect and the level of preassigned rents.     

Accepting market failure: Cultural worldviews and the opposition to corrective environmental policies

To explore whether and why people sometimes reject environmental policies that improve individual and collective outcomes, we create an experimental market in which transactions generate a negative externality. Market participants endogenously determine whether to implement corrective policies. We consider three policy instruments (Pigouvian taxes and subsidies, and quantity regulation) and two levels of policy efficiency (full and half). We then explore how individual cultural worldviews might contribute to the rejection of policies that correct the market failure. Our results indicate that people often oppose policies that improve their material outcomes, and we find that such opposition is significantly explained by cultural worldviews. Interesting connections emerge between individual worldviews and specific policy instruments.     

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.     

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.     

Jobs and climate policy: Evidence from British Columbia's revenue-neutral carbon tax

This paper examines the employment impact of British Columbia's revenue-neutral carbon tax implemented in 2008. While all industries appear to benefit from the redistributed tax revenues, the most carbon-intensive and trade-sensitive industries see employment fall with the tax, while clean service industries see employment rise. By aggregating across industries I find the BC carbon tax generated, on average, a small but statistically significant 0.74 percent annual increases in employment over the 2007–2013 period. This paper provides initial evidence showing how a revenue-neutral carbon tax may not adversely affect employment.     

Plant vintage, technology, and environmental regulation

We use data on productivity and pollution abatement costs at individual pulp and paper mills to test whether the impact of environmental regulation on productivity differs by plant vintage and technology. Plants with higher pollution abatement costs have significantly lower productivity levels. This relationship differs greatly based on a plant's technology, with productivity at integrated mills being greatly affected by abatement costs, while the impact at non-integrated mills is negligible. Plant vintage does not seem to matter, with older and newer plants showing similar impacts. Reported abatement costs appear to substantially understate the true costs of abatement. Accounting for the impact of technology differences makes some difference in the estimated overall impact of environmental regulation.     

Economics of additionality for environmental services from agriculture

We present a model of additionality for offsets sold from agriculture to industrial sector sources regulated by cap-and-trade. We consider a potential policy where agricultural sources would not be covered by cap-and-trade requirements but would be eligible to receive offsets whenever their emissions fall below a policy-specified baseline, and would not be penalized for emissions above their baseline. Major results are: (1) The optimal baseline should be set above the average counterfactual emissions of participating farms, an unexpected result that has been missing from the literature. (2) The optimal trading ratio should be greater than one (a ton of offsets counts for less than a ton of covered emissions) even under emissions certainty. Previous research has justified such trading ratios by emissions uncertainty. (3) Emissions uncertainty does not justify a change in the baseline if the accompanying emissions model is unbiased. (4) An optimal combination of policies is to subsidize offsets and tighten the baseline relative to the no-subsidy case.     

The transition from dirty to clean industries: optimal fiscal policy and the environmental Kuznets curve

This paper investigates privately and socially optimal patterns of economic development in a two-sector endogenous growth model with clean and dirty goods. We consider a second-best fiscal policy framework in which distortionary taxes jointly influence economic growth and environmental quality. In this policy setting, three conditions produce an Environmental Kuznets Curve (EKC): (i) dirty output is bounded; (ii) clean output grows endogenously; and (iii) growth in the dirty sector reduces growth in the clean sector. These conditions do not arise with a consumption externality, but can emerge with a production externality. Endogenous labor supply implications are also investigated. Although not necessary for producing an EKC, endogenous labor supply provides additional linkages that produce an EKC under circumstances in which it would otherwise not appear.     

The switching effect of environmental taxation within Bertrand differentiated duopoly

We investigate second-best optimal taxation of the polluting variety of a product in a Bertrand duopoly with differentiated varieties. The analysis provides novel insight on a useful social function of environmental regulation. Besides internalizing the environmental externality, the taxation of the polluting variety improves the matching of consumers and product varieties, and so creates a socially desirable business switching between the differentiated varieties.     

Inefficient environmental instruments and the gains from trade

The primary result from the trade and environment literature is that countries never lose from trade liberalization as long as they implement optimal pollution targets or if they hold emissions constant. These results are derived in models where the regulators use efficient instruments such as tradable permits or emission taxes. Regulators, however, continue to prefer command and control instruments. I show that regulation under these inefficient instruments (such as design standards or concentration standards) can lead to net losses under trade liberalization even if emissions are optimally adjusted for trade. Furthermore, holding the line on emissions need not guarantee welfare improvements either. The problem is that institutional distortions, the excess costs of inefficient instruments, can rise with trade and offset the material gains from trade. Hence the presumption that we can achieve gains from trade by considering only the level of emissions fails to recognize that the mode of regulation also matters.     

Prices vs quantities with multiple pollutants

We examine the choice of policy instruments (price, quantity or a mix of the two) when two pollutants are regulated and firms' abatement costs are private information. Whether abatement efforts are complements or substitutes is key determining the choice of policies. When pollutants are complements, a mixed policy instrument with a tax on one pollutant and a quota on another is sometimes preferable even if the pollutants are identical in terms of benefits and costs of abatement. Yet, if they are substitutes, the mixed policy is dominated by taxes or quotas.     

Emissions targets and the real business cycle: Intensity targets versus caps or taxes

For reducing greenhouse gas emissions, intensity targets are attracting interest as a flexible mechanism that would better allow for economic growth than emissions caps. For the same expected emissions, however, the economic responses to unexpected productivity shocks differ. Using a real business cycle model, we find that a cap dampens the effects of productivity shocks in the economy on all variables except for the shadow value of the emissions constraint. An emissions tax leads to the same expected outcomes as a cap but with greater volatility. Certainty-equivalent intensity targets maintain higher levels of labor, capital, and output than other policies, with lower expected costs and no more volatility than with no policy.     

Pollution incidence and political jurisdiction: evidence from the TRI

Few issues are more contentious for local communities than industrial pollution. When local industries pollute, lawmakers and regulators must balance two primary concerns: economic prosperity and the environment. The role of political pressure is well documented in environmental policy. What is less clear is the role jurisdictional or boundary considerations play in determining the implementation of environmental laws. Anecdotal evidence suggests that local regulators are more lenient in their treatment of polluters when the incidence of pollution falls partially on those outside the state. One explanation for such behavior is that regulators take actions to maximize political support. This paper tests this jurisdictional model using toxics release inventory (TRI) data from 1987 to 1996. We find that facilities’ emissions into the air and water are systematically higher in counties that border other states. These results are consistent with the hypothesis that jurisdictional considerations are an important determinant of pollution incidence.     

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.     

Environmental federalism and environmental liability

Environmental federalism considers what level of government should optimally regulate pollution. This paper addresses this question for accidental pollution, which government regulates through the ex post liability regimes of either negligence or strict liability. We find that decentralizing the choice between these regimes does not, in general, induce the socially optimal outcome. When firms can pay all damages, all regions may choose negligence and impose an overly strict standard of due care. When firms may be bankrupted by damages, all regions may choose strict liability, which induces too little care. In addition, asymmetric equilibria are possible in which some regions choose negligence, others strict liability. Combining negligence with a Pigovian tax, or strict liability with a bonding requirement can align regional authorities' incentives with those of a central government.     

Prevention and cleanup of dynamic harm under environmental liability

This paper explores incentives for accident prevention and cleanup when firms are subject to environmental liability. In our two-period setup, the level of environmental harm in the second period depends on first-period harm when cleanup was incomplete. Under strict liability, in the first period, firms with a positive probability of going out of business before the second period have inadequate prevention and cleanup incentives. The fundamental disconnect between private incentives and social optimality cannot be remedied by using a multiple of harm as the level of compensation. Under negligence with a causation requirement, incentive problems remain; however, under negligence without such a requirement, first-best incentives may emerge, and using a multiple of harm as the level of compensation can ensure the efficient solution.