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.     

Taxes versus quantities for a stock pollutant with endogenous abatement costs and asymmetric information

We compare emissions taxes and quotas when a (strategic) regulator and (non-strategic) firms have asymmetric information about abatement costs, and all agents use Markov perfect decision rules. Firms make investment decisions that affect their future abatement costs. For general functional forms, firms’ investment policy is information-constrained efficient when the regulator uses a quota, but not when the regulator uses an emissions tax. This advantage of quotas over emissions taxes has not previously been recognized. For a special functional form (linear–quadratic) both policies are constrained efficient. Using numerical methods, we find that a tax has some advantages in this case.     

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.     

Does tax competition make mobile firms more footloose?

We examine a two‐period regional model with evolving economic geography, potentially creating incentives for firm relocation between periods. We argue that tax competition makes firms more footloose, but that this increases efficiency relative to the laissez‐faire outcome. We establish that: (i) tax competition leads to efficient investment outcomes and (ii) firm mobility is greater with tax competition than with a laissez‐faire regime. When relocation is costly, there can be too little mobility over time, as firms do not take into account the impact of FDI on social welfare in each country. With lump‐sum taxes or transfers, firms capture these benefits and internalize them, such that tax competition leads to the efficient outcomes. When more time periods are examined, tax competition induces firm relocation sooner than in its absence.     

Regulating a Polluting Oligopoly: Emission Tax or Voluntary Agreement?

This paper compares, in a polluting oligopoly, an emission tax and a form of environmental policy called voluntary agreement (VA). Here there are two ways of reducing pollution: output contraction and end‐of‐pipe abatement. Given the imperfect competition, firms’ reaction to the tax is sub‐optimal. They reduce output excessively in order to raise the price and do not abate enough. The VA is a take‐it‐or‐leave‐it contract on abatement effort, offered to the firms with the threat of a tax. It has a limited effect on output and always allows higher abatement than the tax. We find that this kind of VA may be more efficient than the tax in a concentrated industry, when pollution is not too harmful and when the abatement technology is rather efficient and cheap.     

The Timing of Environmental Policy: A Note on the Role of Product Differentiation

We examine the role that product differentiation can play in the design of environmental policy under full commitment and no commitment on the part of the environmental regulator. We consider a setting with two firms selling a differentiated product which generates pollution through emissions. Firms can reduce their emissions by undertaking abatement activities while an environmental regulator taxes emissions. The main results are: (1) When products are highly differentiated, the optimal time-consistent (no commitment) tax is always lower than the optimal pre-commitment tax. As the degree of product differentiation decreases, for relatively efficient abatement technology and high damages, the time-consistent emission tax exceeds the optimal pre-commitment one. (2) Abatement when product differentiation is extensive is higher under the time-consistent regime unless the abatement technology is extremely efficient. The same ranking applies to social welfare. However, as products become more and more similar, these results are (partially) reversed and pre-commitment could lead to both higher levels of abatement and welfare.     

Taxes versus quotas for a stock pollutant

We compare the effects of taxes and quotas for an environmental problem where the regulator and polluter have asymmetric information about abatement costs, and environmental damage depends on pollution stock. An increase in the slope of the marginal abatement cost curve, or a decrease in the slope of the marginal damage curve, favors taxes. An increase in the discount rate or the stock decay rate favors tax usage. Taxes dominate quotas if the length of a period during which decisions are constant is sufficiently small. An empirical illustration suggests that taxes dominate quotas for the control of greenhouse gasses.     

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.     

Efficient Climate Policy with Internationally Mobile Firms

A major concern in the design of an incomplete climate agreement is thatfirms that use fossil fuels intensively may respond to emission regulationsby relocating their plants from cooperating to non-cooperating countries.This paper analyses how the cooperating countries might deal with the issueof firm delocation through emission taxes, trade provisions and alocalisation subsidy to mobile firms. It is shown that firms should not beinduced to stay in the cooperating countries by lowering emission taxesbelow the Pigouvian tax rate. Incentives to stay should be given partlythrough trade provisions and partly through a localisation subsidy. A secondbest solution without localisation subsidies is also discussed. In thatcase, the efficient emission tax is lower than the Pigouvian tax rate.Finally, the paper discusses the implications of the first best and thesecond best policy regimes for the pattern of firm localisation.     

Pollution Abatement Subsidies and the Eco-Industry

This paper considers the combination of pollution taxes and abatement subsidies when some polluting firms procure their abatement goods and services from an oligopolistic eco-industry. The regulator must here cope with two simultaneous price distortions: one that comes from pollution and the other which is caused by the eco-industry’s market power. In this context, we show that taxing emissions while subsidizing polluters’ abatement efforts cannot lead to first-best, but the opposite occurs provided it is the eco-industry’s output which is subsidized. When public transfers also create distortions, welfare can be higher if the regulator uses only an emission tax, but subsidizing abatement suppliers while taxing emissions remains optimal when the eco-industry is concentrated.     

Regulating a Polluting Firm Under Asymmetric Information

This paper reinterprets the Laffont-Tirole model of regulation under asymmetric information to cover the case of pollution control. The asymmetry of information concerns the firm's cost of lowering its pollution. The regulator has three objectives: Ensuring an efficient abatement level, generating 'green taxes' and securing the survival of the firm. We show that when optimal abatement is important relative to tax generation, the regulator cannot use the policy of offering the firm a set of linear tax schemes from which to choose. By contrast, this policy is optimal in the Laffont-Tirole model under certain not very restrictive assumptions. We proceed to establish a simple rule for when to shut-down inefficient types. In an example with specific functional forms, we derive the optimal tax function both analytically and graphically. We show the effect on the optimal tax system of a change in a technological parameter.     

Efficient Environmental Policy with Imperfect Compliance

Discussions of efficient environmental policytend to recommend taxes rather than quotas ongrounds of efficiency; a uniform tax willequalize marginal abatement cost betweenpolluters. When polluters' actions are imperfectly observable, the distinction betweentaxes and quotas becomes less clear. Taxes maybe evaded by underreporting of emissions, whilequota violations will not always be discovered.This paper explores the conditions under whichthe efficiency properties of taxes continue tohold even when evasion is possible, and theextent to which the fine for quota violationsplays the same role as a tax on emissions withsimilar efficiency properties.     

Environmental taxation,information precision,and information sharing

We analyze how environmental taxes should be optimally levied in a sequential game in which regulators and firms face costs uncertainties. First, the regulator chooses the intensity of emissions taxes to reduce externalities. Then, facing common and private information with noisy signals, firms compete in the marketplace and choose outputs. We show that, under nonuniform quality of signals across firms, the regulator may calibrate differentiated tax policy. We also show that the social impact of more precise private signals hinges largely and fundamentally on the value of the ratio of the slopes of the marginal damage and the marginal consumer surplus. Finally, we investigate information sharing between polluters and its impacts on welfare. We stress that, when there are threats of severe environmental damages under deep uncertainties, collusion is welfare reducing and may jeopardize the regulatory process. Regulators need to set an appropriate precautionary policy. Numerical simulations illustrate the results that the model delivers.     

Tax Uniformity: A Commitment Device for Restraining Opportunistic Behavior

We show that uniform and differentiated tax systems diverge in their propensity to generate distortionary opportunistic behavior. First, when firms choose investment before the government can commit to its taxes, the tax scheme creates strategic incentives for firms to distort their investment. Second, a system of differentiated taxes has a greater propensity to foster strategic distortions in investment than a uniform tax regime. While the paper makes these points in a set‐up in which polluting firms face an emission tax and invest in abatement, the main message is shown to hold for a wide class of tax policy games.     

What does tax aggressiveness signal? Evidence from stock price reactions to news about tax shelter involvement

We study the stock price reaction to news about corporate tax aggressiveness. We find that, on average, a company's stock price declines when there is news about its involvement in tax shelters. We find some limited evidence for cross-sectional variation in the reaction. For example, the reaction is more negative for firms in the retail sector, suggesting that part of the reaction may be a consumer/taxpayer backlash. In addition, the reaction is less negative for firms that are viewed to be generally less tax aggressive, as proxied by the firm's cash effective tax rate. We interpret this as being consistent with the market reacting positively to evidence that a firm is trying to reduce taxes when their financial reports would lead one to believe the firm is not tax aggressive.     

Non-point source regulation — A self-reporting mechanism

Information feasible regulatory mechanisms (that do not require the regulator to acquire firm level information) have been proposed long ago for stochastic non-point emission problems. These mechanisms do not take polluter cooperation and firm entry–exit incentives simultaneously into account, nor are these issues addressed in an informationally efficient way. In this paper we propose an informationally feasible self-reporting mechanism that is robust to cooperation among polluters while giving participating firms correct abatement incentives as well as giving entry–exit incentives that are correct to a first order approximation.     

Emission taxes and the market for abatement goods and services

This paper examines the effect of emission taxes on pollution abatement and social welfare, when abatement goods and services are provided by a Cournot oligopoly with free-entry. We point out initially that a higher tax not only increases demand for abatement; it also makes polluters less sensitive to price. This attracts a larger number of abatement suppliers while possibly inducing each one of them to produce less. Total abatement always goes up, however, when the delivery of abatement goods and services exhibits decreasing returns to scale. We then calculate the welfare-maximizing emission tax and compare it to the Pigouvian tax.     

Voluntary Environmental Agreements vs. Emission Taxes in Strategic Trade Models

The purpose of the paper is to narrow the gap between the widespread use of voluntary agreements and research on the rationale of such approaches. A topical example are voluntary agreements of many industries to reduce carbon dioxide emissions because of global warming. If the industry anticipates that taxes and fees will be introduced in the coming years, it seems rational to act in advance in order to mitigate the tax levels.The conventional approach in strategic trade and tax models was to look at a two-stage game where governments set taxes first and then firms react. In such a policy regime the government is concerned about the international competitiveness of its firms and sets taxes below marginal damages. In this paper, we consider a policy regime with a reversed timing. Firms commit themselves in the face of emission taxes to abatement efforts and to lower levels of the environmentally intensive output. Then the government introduces the tax. Under this timing of strategies the tax is equal to marginal damage. Firms waive profit and reduce output in order to use less of the polluting input. The reward for this behavior will be a less strict use of policy instruments and hence lower abatement costs in the near future.     

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.     

Asymmetric information, signaling and environmental taxes in oligopoly

This paper examines the effects of signaling on environmental taxation in a two-period oligopoly model in which each firm privately knows whether its technology is clean or dirty, while third parties (the rival firms and the regulator) have only a subjective perception about this fact. Consequently, there are both horizontal and vertical asymmetric information, and each firm can strategically manipulate both, the competitor's and the regulator's priors. In this context, we find that each firm wishes to be perceived as a technologically clean firm in period 2 whenever the regulator's ecological conscience is sufficiently high. We also show that taxes under symmetric information are always positive, but under asymmetric information and signaling they may be negative (subsidies) and lower or greater than in the symmetric information case, depending on the ecological conscience of the regulator and the probability of firms being dirty. Finally, taxes are below environmental marginal damage, both under symmetric and asymmetric information, and signaling reinforces such under-taxation.