Emission Tax or Standard? The Role of Productivity Dispersion

We use a general equilibrium model to address the question whether a regulatory emission standard or an emission tax yields higher societal welfare for any given target on aggregate emission. The key feature of the model is that the plants are heterogeneous in productivity and monopolistically competitive in the production of dirty-goods whose by-product is emission. We …nd that the standard yields higher welfare than the tax if and only if productivity dispersion is small and the monopoly power in the dirty-goods sector is strong. Thus, productivity dispersion should be important in the evaluation of market-based environmental policies relative to nonmarket policies. JEL classi…cations: E60 Keywords: emission tax, standard, productivity dispersion, abatement. We have received useful comments from the participants of the Society for Economic Dynamics meeting (2010), the World Congress of the Econometric Society (2010), the Midwest Macro Meetings (2010) and Shanghai Macro Workshop (2010). Li would like to acknowledge …nancial support by Shanghai Leading Academic Discipline Project (number B801) and the 211 Project. Shi would like to acknowledge …nancial support from the Social Sciences and Humanities Research Council of Canada and the Bank of Canada Fellowship. The opinion expressed here is the authors’own and does not re‡ect the view of the Bank of Canada. 0