Abstract
In the presence of implementation lags, announced Pigouvian taxation leads to fossil fuel prices that are too low from society’s perspective. This results in excessive emissions and reduced incentives for green innovation. Such effects are compounded by the presence of pre-existing subsidies to fossil fuel use. We show that the intertemporal resource tax path may need to be modified to optimally take into account the perverse incentives from policy lags and pre-existing policies. We find that it might be optimal to subsidize, rather than tax resource extraction at the instant of implementation.
Highlights
The need to foster an environmentally sustainable process of economic growth has been the focus of much economic debate since at least the 1980’s (e.g. WCED 1987)
We show that the optimal tax needs to be adjusted in order to correct for both the marginal damages accrued during the interim phase, and the distortion to the private returns to extraction caused by the pre-existing policies
Our discussion in this paper focuses on the optimal way to correct the negative environmental externality associated with the use of fossil fuels in the presence of implementation lags
Summary
The need to foster an environmentally sustainable process of economic growth has been the focus of much economic debate since at least the 1980’s (e.g. WCED 1987). We explicitly allow for the presence of pre-existing taxation or, more realistically in the case of fossil fuels, subsidies In this context, we show that the (second-best) optimal tax needs to be adjusted in order to correct for both the marginal damages accrued during the interim phase, and the distortion to the private returns to extraction caused by the pre-existing policies. Eichner and Pethig (2011) use a two-period, three-region model with non-renewable resources and show, among other things, that an expected, exogenous tightening of the (unilateral) second-period cap by one of the countries, might lead to a global increase in emissions in the first period Relative to these earlier contributions, our emphasis is on optimal (rather than exogenous) policy in the presence of implementation lags. We conclude with a discussion of the possible effects of pre-existing fossil fuel subsidies on optimal policies
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