Abatement innovation in a Cournot oligopoly: emission versus output tax incentives

Abstract

This study compares the utilization of energy and emission taxes as instruments of pollution control and the promotion of advanced abatement technology adoption in a Cournot oligopoly. We examine multistage games in which the government sets the environmental tax rate. Oligopolistic firms may produce two outputs, a final consumption good, whose production causes pollution, and an abatement product, which reduces pollution. Each firm has two types of abatement technology available. One, which we call “standard,” can be utilized without incurring any fixed cost. The other, which we call “advanced,” requires a fixed cost of adoption. The advanced technology is more efficient than the standard technology. We show that the effectiveness of either type of tax depends on the shape of the multiproduct technology. In the absence of economies of scope in the production of energy and abatement, the energy tax reduces pollution, but it is ineffective in promoting technological change. The emission tax, on the other hand, reduces pollution and it is effective in promoting technological change for sufficiently small fixed costs of adoption. In the presence of economies of scope, both types of taxes are effective whenever taxation is necessary for innovation to occur. However, in terms of innovation incentives, the energy tax outperforms the emission tax.