Emission taxes and standards in a general equilibrium with entry and exit

Abstract

This paper studies and compares the welfare effects of emission taxes and emission standards in a general equilibrium model with two sectors in which plants can freely enter and exit. In one of the sectors plants differ in their productivity, produce differentiated goods, and generate emissions that can be reduced using an abatement technology. An emission reduction policy causes resource reallocation among plants and across sectors in two ways: a static way due to the dispersion of productivity and a dynamic way due to entry and exit. The model shows that the static distributional effect favors the emission tax, while the dynamic distributional effect favors the emission standard. Calibrated to Canadian data, the model shows that the dynamic effect dominates the static one and hence the emission standard dominates the emission tax in terms of welfare. This is the case not only in the baseline model, but also in a model with a large variation of parameter values for productivity dispersion, market power, and abatement efficiency.