Prices versus quantities: environmental regulation and imperfect competition

By exercising market power, a firm will distort the production, and therefore the emissions decisions, of all firms in the market. This paper examines how the welfare implications of strategic behavior depend on how pollution is regulated. Under an emissions tax, aggregate emissions do not affect the marginal cost of polluting. In contrast, the price of tradable permits is endogenous. I show when this feedback effect increases strategic firms’ output. Relative to a tax, tradable permits may improve welfare in a market with imperfect competition. As an application, I model strategic and competitive behavior of wholesalers in a Mid-Atlantic electricity market. Simulations suggest that exercising market power decreased emissions locally, thereby substantially reducing the regional tradable permit price. Furthermore, I find that had regulators opted to use a tax instead of permits, the deadweight loss from imperfect competition would have been even greater.     

The Effects of Bailouts and Soft Budget Constraints on the Environment

This paper investigates the effects of financial relief programs, commonly referred to as ‘bailouts’, on pollution. A partial equilibrium soft budget constraint model of the firm is developed to identify the effect of bailouts on the emission decisions of firms. The results from the model indicate that the expectation of bailouts increases ex ante emissions. A more stringent emissions tax is required to achieve the same level of emissions if bailouts are available than if bailouts are not available; however, a tradable permit system will maintain the same emissions level if bailouts are available as when bailouts are not available.     

Are clean technology and environmental quality conflicting policy goals?

We analyze the effects of an environmental policy on the diffusion of a clean technology. Compared to previous articles we consider that the polluting firms are competitors on the output market and we analyze the effects of the policy on the share of adopting firms in the economy. We show that this share is not monotonic with the stringency of the environmental policy. We also compare the effects of an emission tax and tradable pollution permits and we show that, depending again on the stringency of the policy, either the tax or the permits yields a higher degree of technology adoption.     

Investment Incentives Under Emission Trading: An Experimental Study

This paper presents the results of an experimental investigation on incentives to adopt advanced abatement technology under emissions trading. Our experimental design mimics an industry with small asymmetric polluting firms regulated by different schemes of tradable permits. We consider three allocation/auction policies: auctioning off (costly) permits through an ascending clock auction, grandfathering permits with re-allocation through a single-unit double auction, and grandfathering with re-allocation through an ascending clock auction. Our results confirm both dynamic and static theoretical equivalence of auctioning and grandfathering. We nevertheless find that although the market institution used to reallocate permits does not impact the dynamic efficiency from investment, it affects the static efficiency from permit trading.     

Prices versus Quantities in a Second-Best Setting

The choice between taxes and tradable permits has been independently analysed by two distinct research traditions. The first proceeds from Weitzman's partial equilibrium stochastic model and concludes that a tax should be preferred if the marginal abatement cost curve is steeper than the marginal environmental benefit curve. The second utilises deterministic general equilibrium models with pre-existing distortionary taxes. It concludes that non-revenue-raising instruments (e.g., grandfathered tradable permits) are costlier than revenue-raising ones (e.g., a tax on every unit of pollution or auctioned permits). To build a bridge between these two traditions, we introduce in Weitzman's model a positive cost of public funds due to pre-existing distortionary taxes. The tax admits a greater comparative advantage over the permits, as compared to Weitzman's classical result. Then, we assume that the regulated industry blocks any proposal that poses it too high an expected burden. This may require a transfer to firms, in the form of freely-allocated permits or lump-sum tax rebate. It turns out that if this acceptability constraint is binding, then the comparative advantage of taxes over permits is still reinforced. Quantitatively, even if the marginal benefit function is 50% more steeply sloped than the marginal cost function, the price instrument should be preferred. We also compare the expected net benefit of these two instruments to a contingent instrument which leads to the ex post optimum. The superiority of the contingent instrument over the quantity one is higher than in first-best.     

Emission taxes for genuine altruistic firms

This article develops a theoretical model that explores firms' abatement choices. The main results are: First, in a market comprised of a not sufficiently large number of heterogeneous firms always there exists a subset of firms that are willing to undertake abatement activities, if their marginal altruistic cost of emissions is positive. Second, a low emission tax induces abatement when a firm is egoistic or if its altruistic cost of emissions has a concave structure. In contrast, if the firms’ altruistic cost of emissions has a convex structure, then intermediate emission taxes are required. Third, the effect of firms’ altruistic cost of emissions on the emission tax that induce the socially optimum abatement is also conditional on the genuine altruistic preferences and finally, the social planner has an incentive to impose a Pigouvian emission tax when firms are profit maximizers. Otherwise, a lower tax suffices.     

Fees and the Efficiency of Tradable Permit Systems: An Experimental Approach

The paper presents the results of an economic experiment in which the effects of fees on allocative efficiency of tradable utilization permits (e.g. pollution permits) are explored. Laboratory subjects (university students) play the roles of firms whose generic product requires a specific input or permits. Scarcity is exogenously introduced by a fixed supply of tradable production permits. Three treatments are compared: No fee imposed (N); a fixed tax per permit (T); and partial retraction of permits and subsequent redistribution by auction (A). Treatments T and A represent two different ways of imposing fees, which are designed to be revenue equivalent. Our results indicate that, after controlling for deviation of permit prices from a prediction based on fundamentals, fees have an impact on distribution of permits. Interestingly, a fixed tax enhances efficiency compared to the case of no fees while retraction and reallocation by auction tends to reduce efficiency. Apparently, subjects’ decision making is affected by the imposition of fees, but how and to what extent depends on the method used.     

Carbon Trading Reporting: The Case of Spanish Companies

Policy makers, scientists, industry leaders, and academicians all have debated how to restrain global warming and reduce greenhouse gas (GHG) emissions. Three main methods are used: command and control laws and regulations, carbon taxes, and cap and trade schemes. Recognizing the consequences of global warming, all Scandinavian countries introduced a carbon emissions tax in the 1990s. They also ratified the Kyoto Protocol that ran from 2005 through 2012. The European Union (EU) instituted a carbon trading scheme (Emissions Trading System (ETS)) in February 2005 when Kyoto became operative. The three Scandinavian EU members had two methods in place during the 2005–08 period to encourage GHG reduction: taxing and trading. Norway, not in the EU, used just taxes. The other EU members, including Spain, applied just the carbon trading ETS scheme to encourage compliance with the Kyoto Protocol. The fundamental issue addressed is this one: Did publicly held firms headquartered in Spain adequately report participation in the EU carbon emissions trading mechanism? Data to answer this question were obtained from the 2011 and 2012 annual reports for domestic Spanish public companies that received tradable emissions permits. In addition to assessing investor-owned firms’ disclosure posture, the specific method of reporting about carbon emissions permits, whether companies used, banked, or sold the permits granted by the government, also is reviewed. This empirical research effort reports on a complete survey of all available data for the two financial reporting periods that concluded the second phase of the Kyoto Protocol.     

The Cost-Effective Choice of Policy Instruments to Cap Aggregate Emissions with Costly Enforcement

We study the cost-effectiveness of inducing compliance in a program that caps aggregate emissions of a given pollutant from a set of heterogeneous firms based on emissions standards and the relative cost-effectiveness of such a program with respect to an optimally designed program based on tradable discharge permits. Our analysis considers abatement, monitoring and sanctioning costs, as well as perfect and imperfect information on the part of the regulator with regard to the polluters’ abatement costs. Under perfect information we find that (a) the total-cost-effective design of a program based on standards is one in which the standards are firm specific and perfectly enforced, and (b) the total cost of an optimally designed program based on standards is lower than the total cost of an optimally designed transferable emission permits system, except under special conditions. This is true when it is optimum to induce perfect compliance and when it is not. Under imperfect information, nevertheless, it is only by implementing a system of tradable permits and perfectly enforcing it with a constant marginal penalty tied to the price of the permits, that the regulator can surmount the informational problem and at the same time minimize the total cost of the program with certainty.     

Strategic state-level environmental policy with asymmetric pollution spillovers

This paper examines the strategic behavior of state-level utility regulators in the context of the federal tradable emissions permits market when state-to-state pollution spillovers are asymmetric. Strategic behavior is possible because a state’s environmental policy indirectly affects the price of permits and, therefore, abatement in other states. We show that the optimal pollution penalty is comprised of two parts: (i) a Pigouvian tax, adjusted for state-to-state spillovers; and (ii) an optimal tariff designed to improve the terms of trade in permits. Generally, abatement costs are not minimized and the outcome is Pareto inefficient, regardless of the size of the market.     

International emissions trading in a political economy

We examine whether the international emissions trading (IET) scheme can reduce global emissions in a political economy framework. Countries act noncooperatively when choosing the tradable emission permits and the environmental tax. The formulation of environmental policies is influenced by interest groups. Our results show that the effect of IET on global emissions depends crucially on which policies are influenced by lobbying activities. In the case where only environmental taxes are influenced by lobbying, IET tends to reduce global emissions when the capitalists’ political power is strong and, surprisingly, when the environmentalists’ political power is weak.     

Excess Burden of Taxation and Environmental Policy Mix with a Consumer‐Friendly Firm

This study examines the environmental policy mix of tradable emission permits and emission taxes in a duopoly model with a consumer‐friendly firm. We analyse the interplay of the two policies and the welfare consequences in the presence of excess burden of taxation. We show that an emission tax can be redundant when both the excess burden of taxation and the degree of consumer friendliness are insignificant. However, when the excess burden of taxation is significant, tradable permits policy with tax treatment should be applied to enhance welfare in the presence of a consumer‐friendly firm. Finally, under the tax revenue‐neutral case where the excess burden of taxation does not matter, the environmental policy mix is also efficient if the degree of consumer friendliness is sufficiently high.     

Emission taxes and the adoption of cleaner technologies: The case of environmentally conscious consumers

We model a market with environmentally conscious consumers and a duopoly in which firms consider the adoption of a clean technology. We show that as pollution increases, consumers shift more resources to the environmental activities, thereby affecting negatively the demand faced by the duopoly. This effect generates incentives for firms to adopt the clean technology even in the absence of emissions taxes. When such taxes are considered, our results indicate that the benefit of adopting the clean technology is initially increasing and then decreasing in the emission tax. The range of values for which the emission tax increases this benefit becomes narrower when the consumers’ environmental awareness is stronger.     

Taxes,permits, and the diffusion of a new technology

This study looks at the effects of the choice between taxes and permits on the pattern of adoption of a new (pollution) emissions abatement technology. It uses a dynamic setting, where the regulator observes the arrival and initial use of the technology and determines the optimal ex post amount of emissions before firms start to adopt the technology.In the model here, the adoption benefits and costs depend on the number of firms that are already using the technology. Thus, each firm decides the optimal date to adopt the technology, considering its benefits and costs, as well as the advantage they will gain over their rivals, producing a sequence of adoption that is “diffused” into the industry over time.With this framework, the study shows that when the output demand is elastic, auctioned permits induce an earlier diffusion than taxes.     

Tax Competition in Vertically Differentiated Markets with Environmentally Conscious Consumers

This paper analyses the effects of tax competition on environmental product quality, pollution and welfare in a two-country, vertically differentiated, international duopoly, in which consumers are environmentally conscious. The firm in each country chooses first the environmental quality of its product (which reflects the emissions generated in the production process) and then the price. In equilibrium one country will be more polluted than the other because firms choose different levels of environmental quality of their products. We find that a country’s optimal commodity tax is higher if the domestic firm is the more polluting supplier. Furthermore, non-cooperative commodity tax rates are inefficiently high in equilibrium. This is because, in this framework with environmentally aware consumers, commodity taxes affect the choice of firms regarding their emissions. Therefore, a domestic tax reduction not only raises the profits of the foreign firm but also lowers its emission levels, resulting in higher welfare for the other country. We also analyse the optimal cooperative and non-cooperative commodity and emission taxes with border tax adjustments. With these two policy instruments available, commodity taxes are higher.     

Allocation of emission permits with leakage through capital markets

This paper analyses how tradable emission permits should be allocated to firms when capital is internationally mobile. When international environmental problems are attempted solved through uncoordinated policies between countries, it might be desirable for the home country to issue free emission permits in proportion to the use of capital in order to prevent leakage through international capital movements. The desirability of free emission permits will however be reduced if capital also can be employed in a domestic non-polluting sector. In this case, it may even be optimal to tax the use of capital in the polluting sector. It is also shown that it is always optimal to subsidise the use of capital in the polluting sector if the use of labour is taxed at an optimal rate. Finally, leakage does not affect the optimal domestic emission limit as long as appropriate capital subsidies and labour taxes are implementeed.     

Nonpoint Source Pollution Taxes and Excessive Tax Burden

If a regulator is unable to measure firms’ individual emissions, an ambient tax can be used to achieve the socially desired level of pollution. With this tax, each firm pays a unit tax on aggregate emissions. In order for the tax to be effective, firms must recognize that their decisions affect aggregate emissions. When firms behave strategically with respect to the tax-setting regulator, under plausible circumstances their tax burden is lower under an ambient tax, relative to the tax which charges firms on the basis of individual emissions. Firms may prefer the case where the regulator is unable to observe individual firm emissions, even if this asymmetric information causes the regulator to tax each firm on the basis of aggregate emissions.     

On the interaction between imperfect compliance and technology adoption: taxes versus tradable emissions permits

This paper analyzes the effects of the interaction between technology adoption and incomplete enforcement on the extent of violations and the rate of abatement technology adoption. We focus on price-based and quantity-based emission regulations. First, we show that in contrast to uniform taxes, under tradable emissions permits (TEPs), the fall in permit price produced by technology adoption reduces the benefits of violating the environmental regulation at the margin and leads firms to modify their compliance behavior. Moreover, when TEPs are used, the deterrent effect of the monitoring effort is reinforced by the effect that technology adoption has on the extent of violations. Second, we show that the regulator may speed up the diffusion of new technologies by increasing the stringency of the enforcement strategy in the case of TEPs while in the case of uniform taxes, the rate of adoption does not depend on the enforcement parameters.     

Can Allowing to Trade Permits Enhance Welfare in Mixed Oligopoly?

We compare the effects of tradable emission permits (TEP) and non-tradable emission permits (NTEP) in a mixed oligopoly, where public firms and private firms compete in a product market. If all technologies and initial endowments of emission permits are symmetric among public and private firms and if the emission constraint is exogenous and binding, social welfare is greater (resp. smaller) under TEP than under NTEP when the weight of social welfare in each public firm's objective function and the degree of convexity of the production cost function and that of the abatement cost function are small (resp. large).     

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.