Abstract
We analyse two mechanism designs for refunding emission payments to polluting firms: output-based refunding (OBR) and expenditure-based refunding (EBR). In both instruments, emission fees are returned to the polluting industry, typically making the policy more politically acceptable than a standard tax. The crucial difference between OBR and EBR is that the fees are refunded in proportion to output in the former but in proportion to the firms’ expenditure on abatement technology equipment in the latter. To achieve the same abatement target as a standard tax, the fee level in the OBR design is higher, whereas the fee level in the EBR design is lower. The use of OBR and EBR may lead to large differences in the distribution of output and costs across firms. Both designs imply a cost-ineffective provision of abatement, as firms put relatively too much effort into reducing emissions through abatement technology compared with reducing output. However, a standard tax may be politically infeasible and maintaining output may be seen as a political advantage by policymakers if they seek to avoid activity reduction in the regulated sector.
Highlights
It is well known that a uniform tax, levied on all sources of emissions, is a cost-effective instrument to reduce uniformly dispersed emissions
Absent the beforementioned market failures, both expenditure-based refunding (EBR) and output-based refunding (OBR) would be welfare inferior to a standard Pigouvian tax, because they lead to lower output reductions
Activity reductions in local industries, possible job losses, leakage effects, and distributional concerns loom large
Summary
It is well known that a uniform tax, levied on all sources of emissions, is a cost-effective instrument to reduce uniformly dispersed emissions. (See Fullerton and Mohr 2003; Bernard et al 2007; Svendsen et al 2001; Parry et al 2012; Johnson 2006, or Walls and Palmer 2001 for similar points.) Renewable portfolio standards, for example, are similar to EBR from a sector perspective, and induce the result of lower emissions prices but higher overall costs; see Fischer and Preonas (2010) None of these articles, looks at expenditure-based refunding of an emissions tax. Absent the beforementioned market failures, both EBR and OBR would be welfare inferior to a standard Pigouvian tax, because they lead to lower output reductions This comparison between an ideal tax and a refunded one does, assume that the optimal Pigouvian tax is politically feasible, which is often not the case because of political resistance to high taxes. The EBR and OBR systems can be promising options to achieve greater environmental benefits in situations where such political constraints limit the regulator’s use of standard taxes
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