Res econ 262- 4/13/17
Suppose we have only one source of emissions. We will see that if the firm faces an emissions
tax, its incentive to adopt a new cost-saving abatement technology is much greater than when it
faces an emissions standard. This is another reason that economists tend to favor emissions taxes
If the regulator leaves the tax alone after the firm adopts the new technology, the firm will reduce
its emissions to E . Its costs of compliance (abatement costs plus the tax payment)
Compare this to its cost-savings of adopting the new technology if it faced a fixed emissions
standard E*. This would be only area a in the graph. We conclude that a fixed emissions tax
provides a greater incentive for the firm to adopt a new technology than a fixed emissions
The main reason for this conclusion is that the firm has an incentive to reduce its emissions
under a tax when its abatement costs are lower, but it doesn’t when it faces a fixed emissions
Note that leaving the tax unchanged after the firm adopts the new technology will not be
efficient. In the graph below the regulator reduces the tax to its new efficient level, t**, after the
firm adopts the new technology. The firm responds by choosing emissions, E**. Note that the
firm’s cost-savings from adopting the new technology is increased to a + c + d + e when the
regulator reacts to the adoption of the new technology with a lower tax.
Go back to this section of the lecture on Command and Control
Standards to remind yourself of the cost-savings from adopting the new technology when the
firm faced efficient emissions standards. This is area a – b, and we concluded that the firm may
not have an incentive to adopt the new technology.
* The primary point here is that a firm’s incentive to adopt a new technology is greater under an
emissions tax than under an emissions standard.
We could treat the revenues from emissions taxes as a mere transfer from one part of an
economy (polluters) to another (the government and the public). If this is true then these
revenues generate neither social benefits or costs
Double dividend- an emission tax that will reduce pollution and the emissions tax revenues can
be used to reduce other taxes in an economy like income taxes.
1. The primary welfare effect is the value of emissions reductions.
2. The revenue-recycling effect occurs when the revenue generated by taxes is used to
reduced the marginal rates of pre-existing taxes(on labor and capitol)
3. The tax interaction effect- an indirect cost of environmental regulations Environmental regulation→ higher production costs in regulated industries → higher prices for
goods supplied by these industries → higher prices for consumption goods generally → lower
real wages → reduced labor supply.
Bottom line about revenue recycling
Economy-wide cost of emissions control can be reduced if the policy generates public revenue,
and this revenue is used to reduce other taxes that discourage productivity (i.e., labor and capital
However, using emissions tax revenue to reduce tax rates woul