Optimal linear taxation of polluting oligopolists

A linear ad valorem tax can induce homogeneous oligopolists to produce at socially optimal levels, achieving the first-best allocation, in the presence of external costs that vary exogenously with aggregate output. The optimal tax rate is independent of private cost functions and thus reduces informational requirements on the regulator. Alternatively, if the regulator knows marginal private costs but not the pattern of firms' conduct or the slope of the demand curve, an iterative implementation of the tax is possible. Both blockaded and endogenous entry are considered, as is strategic behavior by firms toward the regulator.The views expressed in this paper are those of the author and do not necessarily reflect the views of the Federal Reserve Bank of Philadelphia or of the Federal Reserve System. The author is grateful to Paul Calem for helpful discussions and to two anonymous referees for helpful comments.