Abstract
The paper studies the use of emission taxes and feed-in subsidies for the regulation of a monopoly that can produce the same good with a technology that employs a polluting input and a clean technology. In the first part of the paper, we show that the efficient solution can be implemented combining a tax on emissions and a subsidy on clean output. The tax is lower than the environmental damages, and the subsidy is equal to the difference between the price and the marginal revenue. In the second part of the paper, the second-best tax and subsidy are also calculated solving a two-stage policy game between the regulator and the monopoly with the regulator acting as the leader of the game. We find that the second-best tax rate can be the Pigouvian tax, but only if the marginal costs of the clean technology are constant. Using a linear–quadratic specification of the model, we show that the clean output is larger when a feed-in subsidy is used than when the tax is applied, but the dirty output can be larger or lower depending on the magnitude of marginal costs of the clean technology and marginal damages. The same occurs for the net social welfare, although we find that for low enough marginal costs of the clean technology, the net social welfare is larger when a feed-in subsidy is used to promote clean output regardless the importance of the marginal damages.
Highlights
Environmental regulation of a polluting monopoly is an interesting case of regulation since the market equilibrium can be inefficient because two market failures are operating at the same time but in an opposite direction
Using a linear–quadratic specification, we find out that the clean output is larger when a feed-in subsidy is applied than when a tax is used to control emissions, and that the dirty output can be lower if the marginal costs of the clean technology and the marginal damages are low enough, i.e., we cannot discard that the dirty output when a feed-in subsidy is used can be higher than when a tax is applied
This paper studies the use of emission taxes and feed-in subsidies in the regulation of a polluting monopoly that can produce the same good with a technology that employs a polluting input and an alternative clean technology
Summary
Environmental regulation of a polluting monopoly is an interesting case of regulation since the market equilibrium can be inefficient because two market failures are operating at the same time but in an opposite direction. Our results establish that the efficient solution can be implemented through the market mechanism using an emission tax/feed-in subsidy scheme For this scheme, the subsidy is equal to the difference between the price and the marginal revenue, i.e., equal to the optimal subsidy to apply on total output. The Pigouvian tax is not the optimal tax in this case, but there exists an environmental policy scheme that can implement the first-best This has a clear policy implication since we are able to define a proposal for a market regulation that replicates the efficient outcome without subsidizing the dirty output. The optimal policy would consist of applying a tax on emissions In this case, we have that with the tax, consumers’ surplus is lower than with the subsidy, but the dirty output and environmental damages are lower yielding a higher net social welfare. They could be a good alternative to taxation provided that the clean technology operates with low costs
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