Should Environmental Taxes Be Precautionary?

Abstract

This paper considers whether environmental taxes should be accelerated (or delayed) if the environmental harm from pollution is uncertain and irreversible, and where we are likely to learn more about the nature of the harm or about mitigation technologies in the future. It concludes that environmental taxes should be set equal to expected marginal harm from pollution given the currently available information and should be neither accelerated nor delayed because of the prospect of learning or irreversible harm. The reason is that taxes equal to expected marginal harm decentralize decisions to market participants who will, facing these taxes, make appropriate choices about the timing of pollution. Taxes act similarly to property rights in a complete market where market participants produce Pareto outcomes. There are a number of caveats to this conclusion including the possibility of endogenous learning, in which our understanding of the environmental effects of pollution or the available mitigation technologies depends on the level of taxation.

Keywords: Pigouvian taxation, environmental taxation, precautionary principle, climate change, real options, instrument choice

JEL Classification: H23, K10, Q50