The General Equilibrium Incidence of Environmental Mandates

36 Pages Posted: 30 Nov 2007 Last revised: 25 Jun 2014

See all articles by Don Fullerton

Don Fullerton

University of Illinois at Urbana-Champaign - Department of Finance; National Bureau of Economic Research (NBER); CESifo (Center for Economic Studies and Ifo Institute)

Garth Heutel

University of North Carolina (UNC) at Greensboro - Department of Economics

Date Written: November 2007

Abstract

Regulations that restrict pollution by firms also affect decisions about use of labor and capital. They thus affect relative factor prices, total production, and output prices. For non-revenue-raising environmental mandates, what are the general equilibrium impacts on the wage, the return to capital, and relative output prices? Perhaps surprisingly, we cannot find any existing analytical literature addressing that question. This paper starts with the standard two-sector tax incidence model and modifies one sector to include pollution as a factor of production that can be a complement or substitute for labor or for capital. We then look not at taxes but at four types of mandates, and for each mandate determine conditions that place more of the burden on labor or on capital. Stricter regulation does not always place less burden on the factor that is a better substitute for pollution. Also, a relative restriction on the amount of pollution per unit of output creates an "output-subsidy effect" on factor prices that can offset and reverse the traditional output effect and substitution effect. An analogous effect is found for a relative restriction on pollution per unit of capital.

Suggested Citation

Fullerton, Don and Heutel, Garth, The General Equilibrium Incidence of Environmental Mandates (November 2007). NBER Working Paper No. w13645. Available at SSRN: https://ssrn.com/abstract=1037169

Don Fullerton (Contact Author)

University of Illinois at Urbana-Champaign - Department of Finance ( email )

1206 South Sixth Street
Champaign, IL 61820
United States
(217) 244-3621 (Phone)

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

CESifo (Center for Economic Studies and Ifo Institute)

Poschinger Str. 5
Munich, DE-81679
Germany

Garth Heutel

University of North Carolina (UNC) at Greensboro - Department of Economics ( email )

Greensboro, NC 27402-6165
United States

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