Taxes and Trading Versus Intensity Standards: Second-Best Environmental Policies with Incomplete Regulation (Leakage) or Market Power

33 Pages Posted: 25 Aug 2009 Last revised: 15 Sep 2010

See all articles by Stephen P. Holland

Stephen P. Holland

University of California, Berkeley - Energy Institute; University of North Carolina (UNC) at Greensboro - Bryan School of Business & Economics

Date Written: August 2009

Abstract

This paper investigates whether an emissions tax (equivalent to an emissions cap) maximizes social welfare (defined as the sum of consumer and producer surplus) in the presence of incomplete regulation (leakage) or market power by analyzing an intensity standard regulating emissions per unit of output. With no other market failures, an intensity standard indeed yields lower welfare, although combining it with a consumption tax eliminates this discrepancy. For incomplete regulation, I show that under certain conditions an intensity standard can yield higher welfare than any emissions tax (including the optimal emissions tax). This result persists even with the addition of a consumption tax, which ameliorates output distortions and can sometimes help the intensity standard attain the first best (when an emissions tax/consumption tax combination cannot). Comparing intensity standards to output-based updating shows that the latter yields higher welfare because of its additional flexibility. Finally, I show that with market power an intensity standard can yield higher welfare than the optimal emissions tax. The intuition of these results is relatively straightforward. The weakness of an intensity standard is that it relies more on substitution effects than output effects to reduce emissions. With incomplete regulation or market power, this disadvantage may be helpful since leakage may offset gains from reducing output and since market power already inefficiently reduces output.

Suggested Citation

Holland, Stephen P., Taxes and Trading Versus Intensity Standards: Second-Best Environmental Policies with Incomplete Regulation (Leakage) or Market Power (August 2009). NBER Working Paper No. w15262. Available at SSRN: https://ssrn.com/abstract=1459564

Stephen P. Holland (Contact Author)

University of California, Berkeley - Energy Institute ( email )

310 Barrows Hall
Berkeley, CA 94720
United States

University of North Carolina (UNC) at Greensboro - Bryan School of Business & Economics ( email )

401 Bryan Building
Greensboro, NC 27402-6179
United States

Register to save articles to
your library

Register

Paper statistics

Downloads
9
Abstract Views
258
PlumX Metrics