Optimal Carbon Tax with a Dirty Backstop - Oil, Coal, or Renewables?

36 Pages Posted: 8 Feb 2011

See all articles by Rick van der Ploeg

Rick van der Ploeg

University of Oxford

Cees Withagen

Free University of Amsterdam; Tilburg University

Date Written: January 31, 2011


Optimal climate policy is studied. Coal, the abundant resource, contributes more CO2 per unit of energy than the exhaustible resource, oil. We characterize the optimal sequencing oil and coal and departures from the Herfindahl rule. “Preference reversal” can take place. If coal is very dirty compared to oil, there is no simultaneous use. Else, the optimal outcome starts with oil, before using oil and coal together, and finally coal on its own. The “laissez-faire” outcome uses coal forever or starts with oil until it is no longer profitable to do so and then switches to coal. The optimum requires a steeply rising CO2 tax during the oil-only phase and a less steeply rising CO2 tax during the subsequent oil-coal and coal-only phases to avoid the abrupt switch from oil to coal thus leaving a lot of oil in situ. Finally, we analyze the effects on the optimal transition times and carbon tax of a carbon-free, albeit expensive backstop (solar or wind). Without a carbon tax, a prohibitive coal tax leads to less oil in situ, substantially delays introduction of renewable, and thus curbs global warming substantially. Subsidizing renewables to just below the cost of coal does not affect the oil-only phase. The gain in green welfare dominates the welfare cost of the subsidy if the subsidy gap is small and the global warming challenge is acute.

Keywords: Herfindahl rule, Hotelling rule, non-renewable resource, dirty backstop, coal, global warming, carbon tax, renewables, tax on coal, subsidy on renewables

JEL Classification: Q30, Q42, Q54

Suggested Citation

van der Ploeg, Frederick and Withagen, Cees A. M., Optimal Carbon Tax with a Dirty Backstop - Oil, Coal, or Renewables? (January 31, 2011). CESifo Working Paper Series No. 3334. Available at SSRN: https://ssrn.com/abstract=1756676

Frederick Van der Ploeg

University of Oxford ( email )

Manor Road Building
Manor Road
Oxford, OX1 3BJ
United Kingdom

Cees A. M. Withagen (Contact Author)

Free University of Amsterdam ( email )

Tinbergen Institute De Boelelaan 1105
1081 HV Amsterdam

Tilburg University ( email )

Postbus 90153
Tilburg, DC Noord-Brabant 5000 LE

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