Optimal Taxes on Fossil Fuel in General Equilibrium

48 Pages Posted: 29 Aug 2011 Last revised: 28 May 2022

See all articles by Mikhail Golosov

Mikhail Golosov

Princeton University - Department of Economics

John Hassler

Stockholm University - Institute for International Economic Studies (IIES); Centre for Economic Policy Research (CEPR); CESifo (Center for Economic Studies and Ifo Institute); IZA Institute of Labor Economics

Per Krusell

Princeton University - Department of Economics; Stockholm University - Institute for International Economic Studies (IIES); Centre for Economic Policy Research (CEPR)

Aleh Tsyvinski

Yale University - Cowles Foundation; Yale University

Date Written: August 2011

Abstract

We analyze a dynamic stochastic general-equilibrium (DSGE) model with an externality through climate change from using fossil energy. A central result of our paper is an analytical derivation of a simple formula for the marginal externality damage of emissions. This formula, which holds under quite plausible assumptions, reveals that the damage is proportional to current GDP, with the proportion depending only on three factors: (i) discounting, (ii) the expected damage elasticity (how many percent of the output flow is lost from an extra unit of carbon in the atmosphere), and (iii) the structure of carbon depreciation in the atmosphere. Very importantly, future values of output, consumption, and the atmospheric CO2 concentration, as well as the paths of technology and population, and so on, all disappear from the formula. The optimal tax, using a standard Pigou argument, is then equal to this marginal externality. The simplicity of the formula allows the optimal tax to be easily parameterized and computed. Based on parameter estimates that rely on updated natural-science studies, we find that the optimal tax should be a bit higher than the median, or most well-known, estimates in the literature. We also show how the optimal taxes depend on the expectations and the possible resolution of the uncertainty regarding future damages. Finally, we compute the optimal and market paths for the use of energy and the corresponding climate change.

Suggested Citation

Golosov, Mikhail and Hassler, John and Krusell, Per L. and Tsyvinski, Aleh and Tsyvinski, Aleh, Optimal Taxes on Fossil Fuel in General Equilibrium (August 2011). NBER Working Paper No. w17348, Available at SSRN: https://ssrn.com/abstract=1918677

Mikhail Golosov (Contact Author)

Princeton University - Department of Economics ( email )

111 Fisher Hall
Princeton, NJ 08544-1021
United States

John Hassler

Stockholm University - Institute for International Economic Studies (IIES) ( email )

Stockholm, SE-10691
Sweden
+46 816 2070 (Phone)
+46 816 1443 (Fax)

Centre for Economic Policy Research (CEPR)

London
United Kingdom

CESifo (Center for Economic Studies and Ifo Institute)

Poschinger Str. 5
Munich, DE-81679
Germany

IZA Institute of Labor Economics

P.O. Box 7240
Bonn, D-53072
Germany

Per L. Krusell

Princeton University - Department of Economics ( email )

111 Fisher Hall
Princeton, NJ
United States
609-258-4003 (Phone)
609-258-6419 (Fax)

HOME PAGE: http://rincewind.iies.su.se/%7Ekrusell/

Stockholm University - Institute for International Economic Studies (IIES) ( email )

Stockholm, SE-10691
Sweden
+46 0 8 16 30 73 (Phone)
+46 0 8 16 41 77 (Fax)

HOME PAGE: http://rincewind.iies.su.se/%7Ekrusell/

Centre for Economic Policy Research (CEPR)

London
United Kingdom

Aleh Tsyvinski

Yale University ( email )

New Haven, CT 06520
United States

Yale University - Cowles Foundation ( email )

28 Hillhouse Ave
New Haven, CT 06520-8268
United States
203-432-9163 (Phone)

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