ECONOMIC INCENTIVES (QUASI-MARKET) INSTRUMENTS Emission Taxes And Pollution Abatement Subsidies Transferable (Marketable) Emission Instruments

Emission Taxes And Pollution Abatement Subsidies

Taxation or subsidization may be imposed either on level of particular input or level of emission. Both gives same result in short run. Both taxes and subsidies become part of private cost function and reflect all relevant cost function.

Pre-tax or pre-subsidy marginal benefit

Marginal damage

.
~ M

Emissions, M

Post-tax or post-subsidy marginal benefit

Effect of an emission tax on marginal abatement cost

Marginal abatement cost

Marginal damage cost

.
~ M

0
Post-tax opportunity cost of abatement

Emissions, M

Assumptions that affect tax and subsidy policy:

Tax and subsidy rate should be uniform.

Damage done by pollution is unaffected by time or place. Taxes and subsidies are levied on emission and not on output.

If EPA knows the marginal damage and abatement cost function

MD

MC

~ M

EPA will fix tax rate ~ which will yield social efficient level M~

If EPA knows aggregate marginal abatement cost function and level of pollution they want to achieve

MC

~ M

EPA will fix tax rate ~ which will yield social efficient level M~

If EPA does not know either of the function

MC1

MC2

M2

M1

Difference between long run effect of taxes and subsidies Emission tax = *M*
Abatement subsidy = *(M1 -M*)
Pre-tax or pre-subsidy marginal benefit Post-tax or post-subsidy marginal benefit

*
0

S3

S5 S S4 6
M*

S2

S1
M

An emissions tax and an emissions abatement subsidy (at the same rate) differ in terms of the distribution of gains and losses. This has important implications for the political acceptability and the political feasibility of the instruments. It also could affect the long-run level of pollution abatement under some circumstances, via alteration of the size of the industry.