Environmental Policy and Time Consistency : Emissions Taxes and Emissions Trading
The authors examine policy problems related to the use of emissions taxes, and emissions trading, two market-based instruments for controlling pollution by getting regulated firms to adopt cleaner technologies. By attaching an explicit price to emi...
| Main Authors: | , |
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| Format: | Policy Research Working Paper |
| Language: | English en_US |
| Published: |
World Bank, Washington, DC
2014
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| Subjects: | |
| Online Access: | http://documents.worldbank.org/curated/en/2000/05/437409/environmental-policy-time-consistency-emissions-taxes-emissions-trading http://hdl.handle.net/10986/18852 |
| Summary: | The authors examine policy problems
related to the use of emissions taxes, and emissions
trading, two market-based instruments for controlling
pollution by getting regulated firms to adopt cleaner
technologies. By attaching an explicit price to emissions,
these instruments give firms an incentive to continually
reduce their volume of emissions. Command, and-control
emissions standards create incentives to adopt cleaner
technologies only up to the point where the standards are no
longer binding (at which point the shadow price on emissions
falls to zero). But the ongoing incentives created by the
market-based instruments are not necessarily right, either.
Time-consistency constraints on the setting of these
instruments limit the regulator's ability to set
policies that lead to efficiency in adopting technology
options. After examining the time-consistency properties of
a Pigouvian emissions tax, and of the emissions trading, the
authors find that: 1) If damage is linear, efficiency in
adopting technologies involves either universal adoption of
the new technology, or universal retention of the old
technology, depending on the cost of adoption. The first
best tax policy, and the first-best permit-supply policy are
both time-consistent under these conditions. 2) If damage is
strictly convex, efficiency may require partial adoption of
the new technology. In this case, the first-best tax policy
is not time-consistent, and the tax rate must be adjusted
after adoption has taken place (ratcheting). Ratcheting will
induce an efficient equilibrium if there is a large number
of firms. If there are relatively few firms, ratcheting
creates too many incentives to adopt the new technology. 3)
The first-best supply policy is time-consistent if there is
a large number of firms. If there are relatively few firms,
the first-best supply policy may not be time-consistent, and
the regulator must ratchet the supply of permits. With this
policy, there are not enough incentives for firms to adopt
the new technology. The results do not strongly favor one
policy instrument over the other, but if the point of an
emissions trading program is to increase technological
efficiency, it is necessary to continually adjust the supply
of permits in response to technological change, even when
the damage is linear. This continual adjustment is not
needed for an emissions tax when damage is linear, which may
give emissions taxes an advantage over emissions trading. |
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