Essay！！

Taxes & Subsidies

Richard Martin

University of Victoria

March 21, 2019

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Review

So far we have looked at the two extremes of the policy spectrum: 1 Decentralized: property rights plus either liability or negotiation. 2 Centralized: standards, in particular technological standards.

Today we look at emissions taxes, which fall in the middle of the spectrum (as well as TEP, which we will study next)

The main take away is that the waste disposal services of the environment is a valuable input for production: firms should have to pay a price to use this service.

When firms have to pay for an input they will use it sparingly.

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Location on the policy spectrum.

emission taxes & subsidies:

Require the monitoring of emissions by the government, so they require more government involvement than decentralized solutions. Firms are free to choose what ever level of emissions they wish: there is more freedom for firms to choose than under either performance or technological standards.

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A firm’s response to a tax or subsidy

emission taxes & subsidies:

The firm’s MAC curve tells us how expensive it is for a firm to reduce its emissions marginally. If the firm faces a tax on emissions it will continue to reduce its emissions until MAC = t If the firm faces a subsidy on abatement it will continue to reduce its emissions until MAC = s In terms of static analysis (choosing emissions at a point in time) both a tax on emissions and a subsidy on abatement yield the same behaviour. What would be some potential problems with a subsidy that would make a tax preferable?

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A firm’s response to a tax or subsidy

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emissions

Figure 1: profit maximizing response to a tax or subsidy.

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The socially optimal tax/subsidy

Suppose there are two sources of emissions, and the government knows both the marginal abatement costs and the marginal damages.

MAC1 = MAC2 = MD = p?? = Optimal tax is p?? per unit of emissions. Optimal subsidy is p?? per unit of abatement.

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The socially optimal tax/subsidy

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emissions

Figure 2: Optimal tax/subsidy

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The socially optimal tax/subsidy

Advantages of taxes/subsidies:

Cost effective: for a given level of abatement the abatement cost is automatically minimized because firms choose their abatement to equate their MAC with the price. In other words, because all sources face the same price for emissions their marginal abatement costs are equalized. Obviously we lose cost effectiveness when different jurisdictions have different tax rates. This can be contrasted with a uniform performance standard: MAC would be equalized only if both sources had the exact same MAC curves. The double dividend of a revenue neutral emissions tax.

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The incentive to innovate.

The incentive to innovate:

Emission taxes have a clear advantage over performance standards concerning innovation. In contrast abatement subsidies can create perverse incentives

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The incentive to innovate.

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emissions

Figure 3: Incentive to innovate with unresponsive emissions tax.

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The incentive to innovate.

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emissions

Figure 4: Incentive to innovate with responsive emissions tax.

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The incentive to innovate.

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emissions

Figure 5: Incentive to innovate with unresponsive abatement subsidy.

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The incentive to innovate.

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emissions

Figure 6: Incentive to innovate with responsive abatement subsidy.

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Enforcement

Enforcement:

Enforcement costs should be lower for a tax than for a performance standard. Both policies require exactly the same monitoring (either to establish the size of the tax bill, or to ensure compliance) What causes the difference is the all or nothing aspect of the performance standard. With an emissions tax the tax bill increases linearly with the level of emissions: exceeding the socially optimal level of emissions by one unit yields an increase in the tax bill of t. In contrast, firms will only comply with performance standards if there is a sufficiently harsh punishment for non-compliance: e.g. jail time. The harsher the punishment, the greater the push-back from the source of the emissions in the event of non-compliance: I would do pretty much anything to avoid jail-time!

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Second best taxes.

Second best taxes:

Sometimes it is not feasible to measure emissions: e.g. non-point source emissions such as car emissions. Instead of taxing emissions directly we might tax some component of emissions. Taxing a component of emissions will (probably) reduce emissions but not with the least cost.

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Second best taxes.

Second best taxes: 1 Emissions= cars * kms/cars * emissions/km

If we apply a tax to one component (say emissions/km) people could reduce their emissions/km (purchase a more fuel efficient car) but actually increase their total emissions by driving more. We could tax all components but not clear what combination of taxes would achieve the desired reduction in emissions at least cost.

2 garbage= garbage/bag*bags If we apply a tax to one component (say garbage bags) people could reduce their number of bags but still increase the amount of garbage they produce if they pack more garbage in each bag.

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Deposit/return

Deposit/return

Deposit/return is a hybrid tax/subsidy. When you purchase the good you pay a deposit, when you return the used up product you receive your deposit back. Works well for drink bottles, car parts. The goal is not a reduction in consumption of the good, but rather to ensure that the residual from consumption is recycled properly.

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