Dynamic Inefficiency, Environmental Tax and Climate Change – A DICE Overlapping Generation Model Analysis

Abstract

This study further develops an overlapping generation model based on the DICE model, and applies it to analyze the implicit dynamic inefficiency rooted in climate change issues. Our analytical results suggest that, at the steady state if rational agents take the negative impact of future climate catastrophes into account, they tend to distort their consumption behavior by saving less, thus exacerbating the climate crisis. We propose an environmental tax policy by linking the tax revenue directly with abatement activities, thus at appropriate tax rate range, such a policy can smooth the consumption trajectory, and correct this type of dynamic inefficiencies originated from the decentralized individual rational but collectively irrational behaviors.

Keywords: Climate Change; Environmental Tax; Dynamic Inefficiency; Overlapping Generation Model; DICE Model

JEL Classification: D60, D62, H23, Q28