Optimal Indirect Regulation of Externalities

55 Pages Posted: 22 May 2020 Last revised: 5 Oct 2022

Date Written: April 26, 2020


In many markets ranging from gasoline to alcohol and vaccines, individuals generate different amounts of externalities that cannot be directly taxed. I study how such externalities should be optimally regulated. I characterize the optimal policy and show that it generally requires quantity surcharges and discounts. I evaluate the gain from using the optimal indirect policy rather than a uniform tax and show that it can be significant. I apply my results to gasoline taxes to demonstrate their policy implications. Finally, I incorporate distributional concerns and show how "non-market" solutions such as quantity floors and ceilings might be required.

Keywords: regulation, externalities, mechanism design, imperfect pricing, Pigouvian tax

JEL Classification: D47, D62, D63, D82, H23

Suggested Citation

Kang, Zi Yang, Optimal Indirect Regulation of Externalities (April 26, 2020). Available at SSRN: https://ssrn.com/abstract=3586050 or http://dx.doi.org/10.2139/ssrn.3586050

Zi Yang Kang (Contact Author)

Stanford University ( email )

Stanford, CA 94305
United States

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