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.     

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.     

Environmental taxation and mergers in oligopoly markets with product differentiation

We analyze the effect of mergers on optimal environmental taxation in a Cournot oligopoly market with product differentiation. Our result indicates that the adjustment in emission tax crucially depends on the post-merger output distortion and pollution intensities. Specifically, we find that the optimal emission tax increases post-merger as long as pollution intensity of firms is higher and output distortion smaller post-merger than pre-merger. Furthermore, our result suggests that there is no need to revise environmental policy in markets where pollution intensity of firms does not change post-merger and (i) products are completely differentiated, or (ii) there are many firms for any degree of product differentiation.     

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.     

Environmental protection without loss of international competitiveness

We develop a two‐country Cournot oligopoly model with product differentiation across countries and production‐generated pollution. The abatement of pollution by the firms in response to emission taxes is endogenous, and the number of firms can be fixed or there may be free entry and exit of firms in both countries. We propose particular unilateral and multilateral piecemeal policy reforms of emission taxes and production subsidies such that domestic industries will not suffer any loss of international competitiveness (defined in terms of either market share or profits), emission levels will be lower, and welfare could be higher in both countries.     

Financial structure and the effectiveness of pollution control in an oligopolistic industry

This paper explores the link between pollution taxes and the financial and output decisions of firms in an oligopolistic industry facing demand uncertainty. It is shown that environmental regulations such as pollution taxes may induce firms to alter their financial structure, which in turn influences both output levels and the effectiveness of the tax in controlling pollution emissions. It is demonstrated that there exist circumstances in which highly leveraged firms may respond to pollution taxes by expanding output and emission levels. This possibility arises in a leveraged oligopoly since the tax acts as a credible commitment device which leads to more aggressive competition in output markets.     

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.     

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.     

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.     

Emissions abatement R&D: Dynamic competition in supply schedules

This paper investigates the optimal environmental policy (the mix of emissions tax and research and development [R&D] subsidy) in a dynamic setting when two firms, producing differentiated products, compete in the output market over time. Firms compete in a differential game setting over supply schedules, which encompasses a continuum of imperfect competition equilibria from Bertrand to Cournot. Although production generates environmentally damaging emissions, firms can undertake R&D that has the sole purpose of reducing emissions. In addition to characterizing the optimal policy, we examine how the optimal tax and subsidy, and the optimal level of abatement, change as competition intensifies, as the dynamic parameters change, and as the investment in abatement technology changes. In this setting, competition increases welfare through its impact on the final goods price. However, lower prices result in larger quantities and more pollution. Our key contribution is to show how the impact of increased competition on welfare depends on the extent of the market and the nature of preferences and technology.     

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.     

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.     

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.     

Green Technology and Optimal Emissions Taxation

Unless an active environmental policy exists, firms have no incentive to engage in abatement or environmental R&D so policy design is of paramount importance. This design heavily depends on the way R&D spillovers operate. There are two distinct types of R&D spillover: output spillover and input spillover. An input spillover operates on the expenditure toward pollution reduction, whereas an output spillover manifests as the achieved abatement. Under optimal emissions taxation, significant differences arise due to this distinction, in particular, when the spillover operates on R&D inputs. In an oligopolistic setting, the result is higher R&D expenditure, but also higher aggregate emissions and, consequently, higher emissions taxes. By contrast, when spillovers occur in R&D output, there is a U‐shaped relationship between the optimal tax and the spillover, showing a trade‐off between the optimal tax rate and spillovers when these are low. In terms of the relative effectiveness of different R&D organization setups, combining emissions taxes with R&D cooperation, this paper shows that under low levels of R&D spillover R&D cooperation gives higher emissions reductions, whereas when spillovers are high this is not the case.     

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.     

A Cournot Mechanism for Pollution Control under Asymmetric Information

The contribution of this paper is to show that a simple nonlinear tax can achieve a long-run socially optimal level of pollution without the regulator knowing marginal abatement costs. Firms are charged their differential contribution to total damages, evaluated at the upper margin of current emissions. This induces a Cournot game in pollution levels. We show that the Nash equilibrium exists, corresponds to the socially optimal long-run output and emission levels and number of firms, is stable, and can be reached by iterative computations where conjectures are formed using a linear estimator based on past emission levels.     

Allocation of pollution abatement under learning by doing

This paper examines how learning by doing affects the allocation of pollution abatement between heterogeneous technologies over time. The optimal policy balances current abatement costs against reductions in future costs and infant technologies may be preferred to mature technologies despite greater initial costs. We characterize when a technological winner might emerge and we identify conditions under which optimal abatement is shared across all technologies. Pigouvian taxes can implement the first-best, but may need to be differentiated across technologies. When technical change is induced, an important role of environmental policies is to put abatement on the right technological trajectories.     

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.     

Optimal pollution control in a mixed oligopoly with research spillovers

We study optimal pollution abatement under a mixed oligopoly when firms engage in emissions‐reducing research and development (R&D) with imperfect appropriation. The regulator uses a tax to curb emissions. Results show that in a mixed oligopoly, the public firm has positive emissions reduction in equilibrium; however, emissions reductions of the private firm could be positive or zero. Under certain conditions, the optimal pollution tax is positive; otherwise, the tax reverts to a subsidy. Comparing mixed and private duopolies, privatisation leads to reductions in R&D and output, but to an increase in overall emissions, so privatisation tends to make the environment worse.     

Voluntary Agreements and Non-Verifiable Emissions

If pollution is observable, but some emissions cannot be verified by court,voluntary agreements between a regulator and an industry may bewelfare-improving compared to second-best emission taxes. Such agreementsdiffer from direct regulation in a non-trivial way. The first-best optimummay be included in the set of possible agreements, even if it is notattainable using tax instruments. The non-verifiability may, for example, beassociated with delimitation problems in defining the pollution tax base.