Intertemporal Emission Permits Trading Under Uncertainty and Irreversibility

This paper analyzes the effect of emission permit banking on clean technology investment and abatement under conditions where the stringency of the future cap is uncertain. We examine the problem of heterogeneous firms minimizing the cost of intertemporal emission control in the presence of stochastic future pollution standards and emission permits that are tradable across firms and through time. A firm can invest in clean capital (an improved pollution abatement technology) to reduce its abatement cost. We consider two possibilities: that investment is reversible or irreversible. Uncertainty is captured within a two period model: only the current period cap is known. We show that if banking is positive and marginal abatement costs are sufficiently convex, there will be more abatement and investment in clean technology under uncertainty than there would be under certainty and no banking. These results are at odds with the common belief that uncertainty on future environmental policy is a barrier to investment in clean capital. Moreover, under uncertainty and irreversibility, we find that there are cases where banking enables firms to invest more in clean capital.     

The effects of environmental policies on the abatement investment decisions of a green firm

This paper focuses on environmental policies aimed at rising investment in pollution abatement capital. We assume that ecological uncertainty, i.e., uncertainty over the dynamics of pollution, affects firm investment decisions. Capital irreversibility is not postulated but endogenized using a quadratic adjustment cost function. Using this framework, we study the effects of environmental policies considering taxes on polluting inputs and subsidies to reduce the cost of abatement capital. Environmental policies promoted to enforce abatement capital may generate the unexpected result of reducing the abatement investment rate.     

Efficient Dynamic Pollution Taxation in an Uncertain Environment

This paper analyzes efficient pollution taxation within a stochastic model of endogenous growth. Pollution is a by-product of production and causes disutility. Furthermore, the productivity which results from environmental quality is uncertain. This reflects e.g. uncertain capital depreciation induced by natural disasters like hurricanes or floods. This uncertainty is shown to raise an ambiguous impact on the optimal pollution level as well as on optimal environmental taxation. Market equilibrium turns out to be suboptimal, since the households mis-perceive their individual impact on pollution. Conditions for welfare maximizing pollution taxation are stated and it is shown that a direct pollution tax is not appropriate to yield Pareto-optimal growth. Instead, a linear capital income tax together with a linear abatement subsidy build an efficient tax scheme, if secondarily the governmental budget is balanced. Moreover, an increase in the riskiness of environmental productivity may even lead to an increase in the optimal pollution level and to a decrease in optimal environmental taxation, depending predominantly on the preference parameters.      

Capital accumulation of a firm facing an emissions tax

In this paper we consider the dynamic behavior of a firm that is subject to environmental regulation. It is assumed that, in order to prevent firms from polluting the environment excessively, the government imposes an emissions tax. We determine how an emissions tax influences the firm's decisions concerning investments and abatement efforts. In the model we incorporate the realistic property that a given abatement expenditure leads to more pollution reduction when pollution is large. This property implies increasing returns to scale with respect to pollution reduction. It turns out that, together with the usual assumption of decreasing returns to scale with respect to production, this property leads to the occurrence of history-dependent equilibria in case the pollution tax rate is sufficiently large. It is possible to derive an explicit formula for the threshold tax rate above which these history-dependent equilibria can occur. We show that an investment grant by the government can influence the firm so as to approach the equilibrium with a higher capital stock. Finally, we compare our results with those of a related model where the firm faces a strict pollution standard rather than an emissions tax. Among other things, we show that growth is more suppressed under a tax than under a standard when the firm is small.     

On a Fundamental Advantage of Permits Over Taxes for the Control of Pollution

We extend the tax versus permits literature by considering permit supply functions and pollution tax functions that are generalizations of the usual constant permit supply and constant pollution tax rate. In our model, pollution is not uniformly mixed and the regulator is uncertain about the polluting firms’ abatement costs. We determine the optimal permit supply functions and the optimal pollution tax functions. Using these functions, we show that permits lead unambiguously to lower total expected costs than taxes. We analyze the magnitude of this difference for a simple model of climate change. By relating the optimal permit supply functions to Weitzman (Am Econ Rev 68:683–691, 1978) we provide a new interpretation of his results.     

Optimal Investment and Financial Strategies under Tax‐Rate Uncertainty

Abstract. In this paper, we apply a real‐option model to study the effects of tax‐rate uncertainty on a firm's decision. In doing so, we depart from the relevant literature, which focuses on fully equity‐financed investment projects. By letting a representative firm borrow optimally, we show that debt finance not only encourages investment activities but can also substantially mitigate the effect of tax‐rate uncertainty on investment timing.     

A Note on Emissions Taxes and Incomplete Information

In contrast with what we perceive is the conventional wisdom about setting a second-best emissions tax to control a uniformly mixed pollutant under uncertainty, we demonstrate that setting a uniform tax equal to expected marginal damage is not generally efficient under incomplete information about firms’ abatement costs and damages from pollution. We show that efficient taxes will deviate from expected marginal damage if marginal damage is increasing and there is uncertainty about the slopes of the marginal abatement costs of regulated firms. Moreover, tax rates will vary across firms if a regulator can use observable firm-level characteristics to gain some information about how the firms’ marginal abatement costs vary.     

Irreversible abatement investment under cost uncertainties: tradable emission permits and emissions charges

A major concern with tradable emission permits is that stochastic permit prices may reduce a firm’s incentive to invest in abatement capital or technologies relative to other policies such as a fixed emissions charge. However, under efficient permit trading, the permit price uncertainty is caused by abatement cost uncertainties which affect investment under both permit and charge policies. We develop a rational expectations general equilibrium model of permit trading and irreversible abatement investment to show how cost uncertainties affect investment under permits. We compare the resulting investment incentive with that under charges. After controlling for the assumption that random shocks affect the abatement cost linearly, we find that firms’ investment incentive decreases in cost uncertainties, but more so under emissions charges than under permits. Therefore, tradable permits in fact may help maintain firms’ investment incentive under uncertainty.     

Using a Real‐Options Approach to Model Technology Adoption Under Carbon Price Uncertainty: An Application to the Australian Electricity Generation Sector*

The present climate for investment in electricity generation assets in Australia is uncertain. We develop a real‐options model to contrast the timing of the uptake of various electricity generation technologies under two carbon tax simulations: when a carbon tax of known size commences at a certain date in the future; and a carbon tax of known size commences at an uncertain date in the future. We find that uptake in the future varies significantly depending upon an investor's view of uncertainty and whether the technology is primarily designed to be viable in a market with or without carbon taxes.     

Environmental Quality,Public Debt and Economic Development

This article analyzes the consequences on capital accumulation and environmental quality of environmental policies financed by public debt. A public sector of pollution abatement is financed by a tax or by public debt. We show that if the initial capital stock is high enough, the economy monotonically converges to a long-run steady state. On the contrary, when the initial capital stock is low, the economy is relegated to an environmental poverty trap. We also explore the implications of public policies on the trap and on the long-run stable steady state. In particular, we find that government should decrease debt and increase pollution abatement to promote capital accumulation and environmental quality at the stable long-run steady state. Finally, a welfare analysis shows that there exists a level of public debt that allows a long run steady state to be optimal.     

Government policy to reduce pollution emissions within the overlapping generations model

This article develops an overlapping generations model with multiple categories of capital. The importance of this article is in its ability to analyse changes in the distribution of various categories of capital along the growth path of the economy. Economic growth is accompanied by capital growth as well as increase in pollution emissions. Implementing a government policy to reduce pollution emission would change the equilibrium path of capital distribution. Within the model, the government builds a corporate tax function that defines the tax rate as a function of a ‘desired’ pollution level. The tax rate decreases as the ‘desired’ pollution level is higher. When the ‘desired’ pollution level is higher than the actual pollution level, production is subsidized and pollution levels rise. An example and a simulation are presented in order to confirm the theoretical results and demonstrate that the model can be used for empirical analysis.     

Environmental Funds,Public Abatement,and Welfare

This paper addresses some features of environmental funds that the government uses to finance public abatement with pollution tax revenue or tariff revenue. I find that when the pollution tax rate and the tariff rate are jointly chosen optimally, then the optimal pollution tax rate is higher than the Pigouvian tax rate under public abatement financed by tariff revenue, and lower when public abatement is financed by pollution tax revenue. Furthermore, I show that the optimal tariff rate is positive regardless of which tax revenue is used to finance public abatement. These results are relevant for countries where the government seeks revenues earmarked for the financing of environmental funds.     

The Role of Investment in Environmental Lobbying Contests

This paper establishes that a lobbying stage following investment decisions regarding abatement technology may imply a positive strategic effect of investment, pointing to relatively more investment in pollution abatement technologies than without lobbying. The intuition is that polluting firms may choose to implement more advanced abatement technology as a credible commitment device in order to lower the investment of environmentalists in the lobbying contest that will ultimately determine whether or not an emissions tax is introduced.     

Progressive taxation and the intensity and timing of investment

This paper examines the effect of progressive taxation on a firm's investment intensity and timing decisions using a real options approach. The firm possesses a perpetual option to invest in a project at any instant by incurring an irreversible investment cost at that time. The amount of the irreversible investment cost determines the intensity of investment that augments the value of the project. Tax progression is specified in a particular case of a constant marginal tax rate with an exogenously given tax exemption threshold that makes the average tax rate increase with the tax base. We show that the firm's investment decisions are neutral to tax progression only when the exogenously given tax exemption threshold is sufficiently large. When tax neutrality does not hold, we show that progressive taxation has a perverse effect on investment intensity. Finally, we show that progressive taxation induces the firm to invest earlier as compared to the case under proportional taxation (i.e., in the absence of any tax exemption).     

Disutility of pollution and endogenous growth

Endogenous growth is generally built on a positive externality hypothesis which is the opposite of a negative externality caused by pollution. We study a linear technology with simple assumption: an aggregate capital stock which represents a learning by doing effect and a pollution flow proportional to production. In this framework, we analyse the precise effects on growth of the disutility of pollution and its interaction with the utility of consumption in an economy without abatement technology. The decentralized equilibrium always leads to unlimited growth, but optimal growth is often limited (the negative effect of pollution dominating the positive effect of learning by doing). In this case, the optimal policy which leads the decentralized economy to follow the optimal growth path is to tax capital; in contrast with the optimal subsidy policy in an economy without pollution. When an abatement technology is introduced, the optimal solution can lead the economy to unlimited growth, whatever the form of the utility function.     

Environmental capital flight and pollution tax

This paper analyzes the impacts of a production pollution tax on environmental capital flight and national product in a two-country static general equilibrium model with two-way foreign investment. It is assumed that the capital input in both countries is a composite good of domestic and imported capital. And pollution is assumed to originate in the production process. The productivity of capital in each country is negatively (or positively) related to the worldwide aggregate emissions.The analysis shows that when a domestic pollution tax is levied, domestic capital outflows increase and foreign capital inflows decrease for sufficiently high elasticities of substitution between labor (immobile input) and capital (mobile input) in both countries. Moreover, with negative transnational externalities, increases of a domestic pollution tax reduce domestic production and increase foreign production. The difficulty of substitution between immobile and mobile inputs hinders the optimal allocation of worldwide capital and national product. In this paper, the optimal pollution tax is based on global welfare maximization, not on global income maximization, taking into consideration the impact of income change on individual welfare. Therefore, an optimal pollution tax in the developing country should be lower for a given rate of pollution.     

Pigouvian tax,abatement policies and uncertainty on the environment

The paper examines the effects of environmental uncertainty on Pigouvian tax and abatement policy used, either separately or contemporaneously, to counteract pollution. We discuss these effects by introducing three kinds of risk: risk on the environmental quality, risk on the impact of pollution and risk on the impact of abatement. For each case we determine the conditions ensuring that risk increases the size of public intervention and provide an economic interpretation and some parallelisms with other risk problems. The last part of the paper generalizes some of our results to the case of N-th order risk changes.     

Capital income taxation,depreciation allowances and economic growth: A perfect-foresight general equilibrium model

Conclusions The results indicated in Table 1 show that incomplete depreciation allowances reinforce the distortions in the equilibrium growth path brought about by an ideal capital income tax. A reduction in the deductible share of economic depreciation, like an increase in the tax rate, raises the current level of consumption, but reduces the steady state levels of consumption and capital per efficiency unit of labour.The reason for these distortions is that the tax law is able to drive wedges both between the rate of time preference and the market rate of interest, and between the latter and the marginal productivity of capital. The first wedge is created through capital income taxation as such and its size is directly related to the tax rate. The second wedge is created by the incomplete deductibility of depreciation. Its size is directly related to the tax rate and inversely to the deductible share of depreciation. For the distortion in the growth path of the economy it is the sum of the two wedges that counts. Therefore it is plausible that incomplete depreciation allowances reinforce the effects of capital income taxation.Knowing the determinants of the two wedges one can easily derive the influence of a tax reform on the marginal productivity of capital, the market rate of interest and the rate of time preference (cf. Table 2). In the short run, the system of these three interest rates is anchored by the marginal productivity of capital, and hence any measure that widens a wedge is translated into a reduction in the rate or those rates below the wedge. In the long run the system is anchored by the rate of time preference and an increase in the width of a wedge is translated into an increase in those rates or that rate above this wedge.The paper was written in association with the Sonderforschungsbereich 5 (Staatliche Allokationspolitik im marktwirtschaftlichen System).     

Emission Taxes and Product Differentiation in the Presence of Foreign Firms

Industries characterized by differentiated products are important contributors of greenhouse gases and currently subject to market‐based policies such as emission taxes. In the context of developing countries, fears about foreign investment leaving the country are often used as an argument not to address industry emissions through emission taxes. This paper develops a Cournot model with product differentiation in the presence of abatement efforts where host and foreign firms are subject to an emission tax. The analysis indicates that abatement efforts and differences in pollution intensity coefficients across firms may play a significant role in the characterization of optimal policy. The analysis also suggests that the government may opt to encourage foreign, less pollution‐intensive firms via higher taxation. Additionally, this paper examines how an optimal emission tax may be adjusted as products become more differentiated; industry emissions may fall/rise as a result of more differentiated products. One important contribution of this paper is that it emphasizes the role of abatement efforts, product differentiation, and differences in pollution intensity coefficients across firms in the characterization of the optimal emission tax.     

Weitzman Revisited: Emission Standards Versus Taxes with Uncertain Abatement Costs and Market Power of Polluting Firms

Studies dealing with the optimal choice of pollution control instruments under uncertainty have invariably taken it for granted that regulated firms face perfectly competitive markets. By introducing the product market into the stochastic framework of Weitzman (Rev Econ Stud 41:477–491, 1974), this paper shows for the case of a polluting symmetric Cournot oligopoly that Weitzman’s policy rule for choosing emission standards versus taxes with uncertain abatement costs is biased in the presence of market power. Since the oligopolists take into account their influence on the market price, their total abatement effort, including the restriction of output, is less vulnerable to miscalculations of the tax rate compared to price-taking firms. Consequently, the comparative advantage of instruments is shifted in favour of taxes. In a further step, the provided policy recommendations are generalised by abolishing the assumption that firms are symmetric.