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1997 Progress Report: Effective Environmental Policy in the Presence of Distorting Taxes
EPA Grant Number: R825313Title: Effective Environmental Policy in the Presence of Distorting Taxes
Investigators: Burtraw, Dallas , Goulder, Lawrence , Parry, Ian
Institution: Resources for the Future , National Bureau of Economic Research , Stanford University
EPA Project Officer: Clark, Matthew
Project Period: October 1, 1996 through September 30, 1998
Project Period Covered by this Report: October 1, 1996 through September 30, 1997
Project Amount: $200,000
RFA: Decision Making and Valuation for Environmental Policy (1996)
Research Category: Economics and Decision Sciences
Description:
Objective:This purpose of this research is to investigate the economic cost of policy instruments for environmental protection in the presence of preexisting distortionary taxes. Environmental taxes or other means of raising revenue as a component of environmental policy potentially yield an economic dividend by providing revenue that could be used to reduce preexisting taxes in factor markets such as labor and capital markets. Since all taxes create inefficiency, the reduction of taxes in factor markets would be expected to improve economic efficiency. However, there is another potentially significant indirect economic cost that an environmental tax has when there are preexisting distortionary taxes in factor markets. This cost counteracts the anticipated benefits that might follow from recycling revenue raised by an environmental tax to reduce preexisting taxes.
The insight that motivates this proposal is that environmental policies that do not raise revenues nonetheless are likely to impose a cost through their interactions with preexisting taxes just as would an environmental tax. However, they forgo the potential benefit from recycling environmental tax revenues. In this research we focus primarily on the comparison of revenue-raising and nonrevenue-raising instruments in various settings in evaluating their economic cost in achieving a stated environmental goal.
Progress Summary:The first year of the project has resulted in two completed manuscripts that have been submitted to scholarly journals. One has been accepted for publication. In addition two other manuscripts are nearly complete.
Earlier work on instrument choice has emphasized the efficiency significance of the decision whether to allow trades in emissions rights by converting fixed emissions quotas into tradable emissions permits, by distributing abatement efforts to firms with the lowest cost of reducing emissions. A key result of our work is the finding that the regulatory decision about whether to allocate these permits without charge (for example, so-called "grand fathering" of quotas to emitters based on historic emissions) versus auctioning permits in order to raise revenue can be equally as important in terms of economic efficiency. The cost of grand fathering may well offset the efficiency gains achieved by improving cost effectiveness in compliance activities.
We examine this issue in the context of the SO2 trading program instituted under the 1990 Clean Air Act Amendments. Using a computable general equilibrium model we estimate preexisting taxes raise the cost to the economy of this regulation by $907 million per year. We estimate this to be an additional 70% to the out-of-pocket compliance cost for the program. More than half of the additional cost reflects the failure of the program to raise revenue that could be used to reduce preexisting(labor) taxes. Were the program to raise revenue, this could reduce this cost by $533 according to our model.
Another paper examines the economic efficiency of two policies to reduce carbon emissions in the U.S. a carbon tax and a tradable quota (permit) system with quotas allocated at zero charge. The tax interactions significantly raise the costs of both policies relative to what they would be in the absence of preexisting taxes, sometimes called the "first-best" setting. In the more realistic "second-best" setting that includes preexisting taxes, the cost of both policies are much higher. However, we show that the tax interactions put the quota system at a significant efficiency disadvantage relative to the carbon tax. The costs of reducing emissions by 10 percent are more than 300 percent higher under the quota system than under the tax. This disadvantage reflects the inability of the quota policy to generate revenue that can be used to reduce preexisting distortionary taxes.
Journal Articles on this Report: 5 Displayed | Download in RIS Format
| Other project views: | All 55 publications | 14 publications in selected types | All 10 journal articles |
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Goulder LH, Parry I, Burtraw D. Revenue-raising versus other approaches to environmental protection: the critical significance of preexisting tax distortions. RAND Journal of Economics 1997;28(4):708-731. |
R825313 (1997) R825313 (Final) |
not available |
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Goulder LH, Parry I, Williams RC, Burtraw D. The cost-effectiveness of alternative instruments for environmental protection in a second-best setting. Journal of Public Economics, June 1999;72(3):329-360. |
R825313 (1997) R825313 (1998) R825313 (Final) |
not available |
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Parry IWH, Williams RC, Goulder LH. When can carbon abatement policies increase welfare? The fundamental role of distorted factor markets. Journal of Environmental Economics and Management 1999;37(1):52-84 |
R825313 (1997) R825313 (1998) R825313 (Final) |
not available |
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Parry IWH, Williams RC. A second-best evaluation of eight policy instruments to reduce carbon emissions. Resource and Energy Economics 1999;21(3-4):347-373 |
R825313 (1997) R825313 (1998) R825313 (Final) |
not available |
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Parry, IWH. Revenue recycling and the costs of reducing carbon emissions. In: Toman MA, ed. Climate Change Economics and Policy: An RFF Anthology. Washington, DC: Resources for the Future, 2001, pp. 119-124. |
R825313 (1997) R825313 (1998) R825313 (Final) |
not available |
Economic, Social, & Behavioral Science Research Program, Scientific Discipline, RFA, Social Science, decision-making, Economics & Decision Making, Ecology and Ecosystems, Economics, air pollution policy, compliance costs, government regulatory costs, ecosystem valuation, public policy, environmental tax, decision analysis, emissions quotas, environmental policy, cost effectiveness, regulations, carbon sequestration, valuation, economic benefits
Progress and Final Reports:
Original Abstract
1998 Progress Report
Final Report