Costs of Alternative Environmental Policy Instruments in the Presence of Industry Compensation Requirements

CentER Discussion Paper Series No. 2006-127

53 Pages Posted: 14 Jan 2007

See all articles by A. Lans Bovenberg

A. Lans Bovenberg

Tilburg University - Center for Economic Research (CentER); Centre for Economic Policy Research (CEPR); CESifo (Center for Economic Studies and Ifo Institute)

Lawrence H. Goulder

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

Mark R. Jacobsen

University of California, San Diego (UCSD) - Department of Economics; Stanford University

Date Written: November 2006

Abstract

This paper explores how the costs of meeting given aggregate targets for pollution emissions change with the imposition of the requirement that key pollution-related industries be compensated for potential losses of profit from the pollution regulation. Using analytically and numerically solved equilibrium models, we compare the incidence and costs of emissions taxes, fuel (intermediate input) taxes, performance standards and mandated technologies in the absence and presence of this compensation requirement. Compensation is provided either through industry tax credits or industry-specific cuts in capital tax rates. We decompose the added costs from the compensation requirement into (1) an increase in intrinsic abatement cost, reflecting a lowered efficiency of pollution abatement, and (2) a lump-sum compensation cost that captures the efficiency costs of financing the compensation. The compensation requirement affects these components differently, depending on the policy instrument involved and the required extent of pollution abatement. As a result, it can change the cost-rankings of the different instruments. In particular, when compensation is provided through tax credits, the lump-sum compensation cost is higher under the emissions tax than under the command-and control policies (performance standards and mandated technologies) - a reflection of the higher compensation requirements under the emissions tax. When the required pollution reduction is modest, imposing the compensation requirement causes the emissions tax to lose its status as the least costly instrument and to become more costly than command and control policies. In contrast, when required abatement is extensive, the emissions tax again becomes the most-cost effective instrument because of its advantages in terms of lower intrinsic abatement cost.

Keywords: environmental instrument choice, pollution control, compensation requirements, emissions abatement costs

JEL Classification: Q58, H23, H21

Suggested Citation

Bovenberg, A. Lans and Goulder, Lawrence H. and Jacobsen, Mark R., Costs of Alternative Environmental Policy Instruments in the Presence of Industry Compensation Requirements (November 2006). CentER Discussion Paper Series No. 2006-127, Available at SSRN: https://ssrn.com/abstract=956847 or http://dx.doi.org/10.2139/ssrn.956847

A. Lans Bovenberg

Tilburg University - Center for Economic Research (CentER) ( email )

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Tilburg, 5000 LE
Netherlands
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Centre for Economic Policy Research (CEPR)

London
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CESifo (Center for Economic Studies and Ifo Institute)

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Germany

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Lawrence H. Goulder (Contact Author)

Stanford University - Department of Economics ( email )

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National Bureau of Economic Research (NBER)

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Resources for the Future

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Mark R. Jacobsen

University of California, San Diego (UCSD) - Department of Economics ( email )

9500 Gilman Drive
La Jolla, CA 92093-0508
United States

Stanford University ( email )

Stanford, CA 94305
United States

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