Biofuels and Climate Change Mitigation: A CGE Analysis Incorporating Land-Use Change

We examine the impact of a “green network effect” in a market characterized by consumers’ environmental awareness and competition between firms in terms of both environmental quality and product prices. The unique aspect of this model comes from the assumption that an increase in the number of consumers of green (brown) product increases the satisfaction of each green (brown) consumer. We show that, paradoxically, when the network effect of a green product is higher than that of a brown product, this externality reduces product environmental quality and raises consumption of the green product. Conversely, when the network effect of the brown product is higher, the externality improves product environmental quality and raises consumption of the brown product. In both cases, the network effect does not affect the overall pollution level. The externality correction requires the use of three optimal fiscal policies: an ad valorem tax on products, an emission tax, and a subsidy or a tax on the green purchase. A second-best optimum can also be reached through the green taxation.     

Would my driving pattern change if my neighbor were to buy an emission-free car?

Aiming to reduce the number of brown (polluting) cars on the road, several countries currently promote the purchase and use of green (emission-free) cars through financial and non-financial incentives. We study how such incentives affect consumers who continue to drive brown cars. Using a simple model, we analyze the effects of policy instruments such as subsidizing green cars, taxing brown cars, and allowing green cars to drive in bus lanes. Car owners are influenced by price incentives as well as by external effects from traffic (such as congestion) both in regular lanes and in bus lanes. An extension of the model also considers how changes in local driving habits affect brown-car driving. We find that subsidizing green cars and allowing them to drive in bus lanes might increase brown-car driving. We also report the results of a recent survey containing questions specifically designed to tap the significance of the model’s core mechanisms. The results are partially consistent with propositions derived from the model. While most brown-car respondents report their driving was unchanged after the implementation of the policies to promote green cars, some – particularly in major cities – report that these policies caused them to reduce or increase their driving. We conclude that some mechanisms in our model are more important than others and that certain mechanisms appear to influence different brown-car drivers in different ways. Overall, it seems that Norwegian policies to promote the transition from brown to green cars have somewhat reduced brown-car driving.     

Environmental Goods and Measures for Their Promotion: An Analysis Using a Fair Wage Model

In this paper, we model a two‐sector small open economy with emissions and unemployment associated with the fair wage effort hypothesis, and investigate the environmental and employment impact of an emission tax, a subsidy for purchasing environmental goods in the downstream polluting industry, and a subsidy to the upstream eco‐industry. We then show that if the eco‐industry is skilled labor intensive relative to the polluting final goods industry, while a subsidy for purchasing environmental goods decreases the unemployment rate of unskilled labor, it may increase total emissions. In contrast, the emission tax and the subsidy to eco‐industry firms worsen the unemployment rate, though both policies decrease total emissions. Hence, if the emission tax is set equal to the marginal environmental damage, and either a downstream or upstream subsidy is used to mitigate unskilled unemployment, the optimal subsidy to purchase the goods is positive whereas the optimal subsidy to the eco‐industry is negative, i.e., a tax on the eco‐industry.     

On the paradoxical case of a consumer-based environmental subsidy policy

We apply an environmentally differentiated duopoly model to the analysis of environmental policy involving consumer subsidies based on the emission levels of the products consumers purchase. More specifically, we consider the environmental and welfare effects of subsidizing consumers who purchase environmentally friendly goods in the case of a partially covered market with a Cournot duopoly. We show that, paradoxically, the subsidy policy degrades the environment, and that the optimal policy depends on the degree of marginal social valuation of environmental damage. That is, if the marginal social valuation of environmental damage is larger than a certain value, a consumer-based environmental subsidy policy is not socially optimal.     

Implications of incorporating domestic margins into analyses of energy taxation and climate change policies

In most applied general equilibrium (AGE) analyses, the domestic transportation, wholesaling, and retailing services that facilitate the flow of goods and services from producers to consumers are not identified by commodity or use. Because the margins on energy commodities can be substantial, ignoring these domestic margins has important consequences when analyzing the impacts of policies designed to limit greenhouse gas emissions. This paper incorporates domestic trade and transport margins into the GTAP-E model, which has previously been used to analyze climate change policies. Models that do not explicitly incorporate domestic margins over-estimate the reduction in CO₂ emissions from a given carbon tax or under-estimate the level of a carbon tax needed to achieve a specific abatement target when domestic margins are fixed or when the carbon tax is treated as a consumption tax with variable domestic margins. However, this result can be reversed when the carbon tax is treated as an output tax with variable domestic margins.     

On the Time Inconsistency of Optimal Monetary and Fiscal Policies with Many Consumer Goods*

In this paper, we study the time consistency of optimal policies in an environment where agents use cash to purchase many consumer goods and where those goods might be taxed at differential rates. Our main result is that optimal monetary and fiscal policies are, in general, time‐inconsistent, because the number of bond instruments is insufficient to influence all future fiscal decisions. However, there is one special case where optimal policies are time‐consistent, which is when differential tax rates across cash goods are optimally zero.     

Using corrective taxes to remedy consumer misperceptions

When consumers are misinformed about the amount of characteristics obtained from some good, government may attempt to correct the misperceptions by imposing taxes or subsidies on these goods. Such a policy, however, faces difficulties: only with separable utility functions does a single tax suffice, and this tax should not induce consumers to purchase t he same bundle they would under perfect information.     

Nonlinear Pricing, Redistribution, and Optimal Tax Policy

This paper examines the role of nonlinear pricing by public (or regulated) utilities as a redistributive mechanism in presence of an optimal nonlinear income tax. It models an economy with many types of persons who differ in two unobservable characteristics (earning abilities and tastes). We show that nonlinear pricing does have a redistributive role; it is not a substitute for an ill-designed tax policy. We prove, assuming separable preferences, that a person whose valuation of the public sector output is smaller than the average valuation of the population (all measured at the same consumption bundle) must face a marginal price for the good above its marginal cost. Further assuming that tastes and earning abilities are perfectly correlated, we prove that everyone must face a marginal price for the public sector's output which strictly exceeds its marginal cost if correlation is positive. These properties provide an economic rationale for the provision of "support for low-income consumers" as mandated by the universal service and similar regulatory policies. Finally, we show that with correlated characteristics, implementation can be achieved through two separate functions: a pricing function that depends only on the public sector output and a tax function that depends only on income.     

Editorial announcement

In this paper we develop a general equilibrium model of the Mexican economy in which unemployment and government deficits play important roles. The unemployment rate depends on a downwardly rigid real wage in the urban sector. The government runs a deficit simply by selling bonds that consumers consider perfect substitutes for physical capital as savings instruments. The model is used to analyze the impact of the 1980 fiscal reform. The presence of the rigid real wage and alternative specifications of government policies regarding the size of the deficit are found to have significant effects on the comparative statics results. Whether or not the reform improves the welfare of rural households compared to urban households, for example, depends on whether government policy is to keep the deficit constant or keep expenditures constant in response to changes in tax revenues.     

Greenhouse Gas Abatement Cost Curves of the Residential Heating Market: A Microeconomic Approach

In this paper, we develop a microeconomic approach to deduce greenhouse gas abatement cost curves of the residential heating sector. Our research is based on a system dynamics microsimulation of private households’ investment decisions for heating systems to the year 2030. By accounting for household-specific characteristics, we investigate the welfare costs of different abatement policies in terms of the compensating variation and the excess burden. We investigate two policies: (i) a carbon tax and (ii) subsidies on heating system investments. We deduce abatement cost curves for both policies by simulating welfare costs and greenhouse gas emissions to the year 2030. We find that (i) welfare-based abatement costs are generally higher than pure technical equipment costs; (ii) given utility maximizing households a carbon tax is the most welfare-efficient policy and; (iii) if households are not utility maximizing, a subsidy on investments may have lower marginal greenhouse gas abatement costs than a carbon tax.     

Ecological dumping under foreign investment quotas

In this paper, we examine the discrimination of emission taxes between the export and nontradable sectors in a small open economy. A few articles indicate that there should be no differentiation of environmental policies between sectors in the economy if the government uses indirect instruments such as emission taxes. However, we show that discrimination of emission taxes may occur in an economy that imposes foreign investment quotas. In particular, the possibility that ecological dumping occurs is higher if export goods are more labor intensive than import goods (as in developing countries). Moreover, in the case where import goods are the most capital intensive, both emission tax rates may be lower than the marginal environmental damage, and ecological dumping may occur. It is also shown that easing foreign capital quotas may deteriorate the country’s welfare.     

Fiscal policy,macroeconomic performance and industry structure in a small open economy

We analyse how fiscal policy affects both the macroeconomy and the industry structure, using a multi-sector macroeconomic model of the Norwegian economy with an inflation targeting monetary policy. Our simulations show that the magnitude of the government spending and labour tax cut multipliers, whether monetary policy is active or passive, is comparable to what is found in the literature. A novel finding from our simulations is that the industry structure is substantially affected by an expansionary fiscal policy, as value added in the non-traded goods sector increases at the expense of value added in the traded goods sector. Moreover, expansionary fiscal policy reduces the mark-ups in the traded goods sector, while the mark-ups are roughly unchanged in the non-traded goods sector. The contraction of activity in the traded goods sector increases when monetary tightening accompanies the fiscal stimulus. Hence, we find that such a policy mix is likely to produce significant de-industrialization in a small open economy with inflation targeting.     

General Equilibrium Impacts of Monetary and Fiscal Policies on Welfare of Households in South Asia

Impacts of fiscal and monetary policies are assessed in an open economy two sector multi‐household general equilibrium tax model with money for South Asia. Despite impressive growth rates there is evidence for alarming gaps in the distribution of income among households that require very careful design of economic policies. Generally the impacts of fiscal expansions are positive for all categories of households under the flexible price system but the gains are much higher for households in the upper income group than for those in the bottom. In theory the equilibrium relative prices guarantee the optimal allocation of resources in such economy. Simulation results show that demand, output and employment are sensitive to the preferences of consumers, confidence of producers and sector specific production technologies. Monetary policy is super‐neutral under flexible price regime but can complement fiscal policy well when aggregate prices are made sticky. Combination of monetary and fiscal policies in this manner can have extensive impacts in efficiency and redistribution. Higher taxes distort incentives to work and investment from richer households slowing down the economy. This reduces the welfare level of both rich and poor. Flexibility in prices enhances the market mechanism and makes the fiscal policy more effective and efficient.     

Effects of subsidies on growth and welfare in a quality-ladder model with elastic labor

This paper develops a quality-ladder growth model with elastic labor supply and distortionary taxes to analyze the effects of different subsidy instruments: subsidies to the production of final goods, subsidies to the purchase of intermediate goods, and subsidies to research and development (R&D). Moreover, the model is calibrated to the US data to compare the growth and welfare implications of these subsidies. The main results are as follows. First, we analytically show that an optimal coordination of all instruments attains the first-best outcome. Second, in the calibrated economy, we numerically find that for the use of a single instrument, R&D subsidy is less growth-enhancing and welfare-improving than the other subsidies, whereas for the use of a mix of two instruments, subsidizing the production of final goods and the purchase of intermediate goods is most effective in promoting growth but least effective in raising welfare.     

Optimal climate and fiscal policy in an OLG economy

This paper develops a climate–economy model to study the joint design of optimal climate and fiscal policies in economies with overlapping generations (OLGs). I demonstrate how capital taxation, if optimal, drives a wedge between the market costs of carbon (the net present value of marginal damages using the market interest rate) and the Pigouvian tax (the net present value of marginal damages using the consumption discount rate of successive OLGs). In contrast to deterministic infinitely lived representative agent models, at the optimum, the capital income tax is positive, the carbon price equals the market costs of carbon but it falls short of the Pigouvian tax when (i) preferences are not separable over consumption and leisure; and (ii) labor income taxes cannot be age-dependent. I also show that restrictions on climate change policy provide a novel rationale for positive capital income taxes.     

Managing Permit Markets to Stabilize Prices

The political economy of environmental policy favors the use of quantity-based instruments over price-based instruments (e.g., tradable permits over green taxes), at least in the United States. With cost uncertainty, however, there are clear efficiency advantages to prices in cases where the marginal damages of emissions are relatively flat, such as with greenhouse gases. The question arises, therefore, of whether one can design flexible quantity policies that mimic the behavior of price policies, namely stable permit prices and abatement costs. We explore a number of “quantity-plus” policies that replicate the behavior of a price policy through rules that adjust the effective permit cap for unexpectedly low or high costs. They do so without necessitating any monetary exchanges between the government and the regulated firms, which can be a significant political barrier to the use of price instruments.     

Devaluation, Asymmetric Money Demand, and Investment in a Small Open Economy

This paper investigates the relationship between inflation and investment when cash is required to purchase some consumption goods in a small open economy while others are purchased with foreign currency or on credit. Devaluation acts as a differential tax on the good that must be purchased with domestic money and lowers the return to the factor used intensively in this sector. If this sector is relatively labor intensive, the steady-state capital stock will increase in response to higher inflation. Nonneutrality of inflation exists even though money is only held for consumption purposes.     

Competition,taxation and economic growth

The paper mainly examines the relationship between economic growth, tax policy and sectoral labor distribution in an endogenous growth model with expanding varieties. For analyzing these relationships, we consider an economy where three sectors of production are vertically integrated: final goods sector, intermediate goods sector and research sector. We show that the extent of imperfect competition in the intermediate products market affects both economic growth and the allocation of the available labor to all the sectors employing this input. The resources from capital taxation, which are used for financing research sector, have a U-shaped effect on growth and lead to a movement of the labor from research sector to final goods sector. Additionally, we show that if there exists a higher competitive structure in an economy, the probability of the positive effect of an increase in tax on growth gets higher.     

Output‐based rebating of carbon taxes in a neighbour's backyard: Competitiveness,leakage and welfare

We investigate how, in an open economy, carbon taxes combined with output‐based rebating (OBR) perform in interaction with the carbon policies of a large neighbouring trading partner. Analytical results suggest that, whether the purpose of the OBR policy is to compensate firms for carbon tax burdens or to maximize welfare (accounting for global emission reductions), the OBR rate should be positive in policy‐relevant cases. Numerical simulations for Canada, with the US as the neighbouring trading partner, indicate that the impact of US policies on the OBR rate will depend crucially on the purpose of the Canadian OBR policies. If, for a given US carbon policy, Canada's aim is to restore the competitiveness of domestic emission‐intensive and trade‐exposed (EITE) firms to the same level as before the introduction of its own carbon taxation, we find that the necessary domestic OBR rates will be insensitive to the foreign carbon policies. However, if not only the Canadian carbon tax but also an equally high US tax is introduced, compensatory Canadian OBR rates will be up to 50% lower, depending on the sector and on US OBR policy. If the policy objective is to increase economy‐wide allocative efficiency (welfare) of Canadian policies by accounting for carbon leakage, the US policies will have only a minor downward pressure on desirable OBR rates in Canada. Practical choices of OBR rates hardly affect overall domestic economic performance; thus, output‐based rebating qualifies as an instrument for compensating EITE industries without a large sacrifice in terms of economy‐wide allocative efficiency.     

Uncertainty, Commitment, and Optimal Taxation

This paper examines the optimal tax design problem in the presence of wage uncertainty. The wage has a continuous distribution, individuals are ex ante identical, preferences are separable in labor supply and goods, public policy aims at providing the population with social insurance, and the only restriction on the tax instruments is that emanating from lack of public observability of realized wages and labor supplies. We show that optimal tax structures depend crucially on whether it is labor supply or goods that consumers have to commit to before the resolution of uncertainty. Specifically, we prove that, in the absence of commitment, the social insurance problem collapses to the traditional optimal tax problem. Second, if labor supply is precommitted, it would be possible to effect a first-best outcome. Third, commitment to goods would make indirect taxation a useful instrument of tax policy even in the presence of a general income tax; it requires differential tax treatment of committed and noncommitted goods. Finally, if preferences are separable between the two types of goods, precommitted goods must be taxed at a uniform rate lower than that on the noncommitted goods.