The Cost-Effectiveness of Alternative Instruments for Environmental Protection in a Second-Best Setting

Posted: 23 Mar 1998

See all articles by Lawrence H. Goulder

Lawrence H. Goulder

Stanford University - Department of Economics; National Bureau of Economic Research (NBER); Resources for the Future

Ian W. H. Parry

Resources for the Future

Roberton C. Williams

University of Maryland - Department of Agricultural & Resource Economics; National Bureau of Economic Research (NBER); Resources for the Future

Dallas Burtraw

Resources for the Future

Multiple version iconThere are 3 versions of this paper

Date Written: January 1998

Abstract

This paper employs analytical and numerical general equilibrium models to examine the costs of achieving pollution reductions under a range of environmental policy instruments in a second-best setting with pre-existing factor taxes. We compare the costs and overall efficiency impacts of emissions taxes, emissions quotas, fuels taxes, performance standards, and mandated technologies, and explore how costs change with the magnitude of pre-existing taxes and the extent of pollution abatement.

We find that the presence of distortionary taxes raises the costs of pollution abatement under each instrument relative to its costs in a first-best world. This extra cost is an increasing function of the magnitude of pre-existing tax rates. For plausible values of pre-existing tax rates and other parameters, the cost increase for all policies is substantial (35 percent or more). The impact of pre-existing taxes is particularly large for non-auctioned emissions quotas: here the cost increase can be several hundred percent. Earlier work on instrument choice has emphasized the potential reduction in compliance cost achievable by converting fixed emissions quotas into tradeable emissions permits. Our results indicate that the regulator's decision whether to auction or grandfather emissions rights can have equally important cost impacts. Similarly, the choice as to how to recycle revenues from environmentally motivated taxes (whether to return the revenues in lump-sum fashion or via cuts in marginal tax rates) can be as important to cost as the decision whether the tax takes the form of an emissions tax or fuel tax, particularly when modest emissions reductions are involved.

In both first- and second-best settings, the cost differences across instruments depend importantly on the extent of pollution abatement under consideration. Total abatement costs differ markedly at low levels of abatement. Strikingly, for all instruments except the fuel tax these costs converge to the same value as abatement levels approach 100 percent.

JEL Classification: D58, H21, L51

Suggested Citation

Goulder, Lawrence H. and Parry, Ian W. H. and Williams, Roberton C. and Burtraw, Dallas, The Cost-Effectiveness of Alternative Instruments for Environmental Protection in a Second-Best Setting (January 1998). Available at SSRN: https://ssrn.com/abstract=69210

Lawrence H. Goulder (Contact Author)

Stanford University - Department of Economics ( email )

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Ian W. H. Parry

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Roberton C. Williams

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Dallas Burtraw

Resources for the Future ( email )

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