Emission Tax or Standard: The Roles of Productivity Dispersion and Abatement

When a society wants to control aggregate emission under a certain target level, is it more desirable to impose a tax or a regulatory standard on emission? To answer this question, we explore a model where plants are heterogeneous in productivity and monopolistically competitive in the production of a set of varieties of (dirty-) goods whose by-product is emission. We establish three main results. First, if the technology on emission abatement is not available, then an emission tax unambiguously generates higher welfare than an emission standard. Second, if the plants can use the abatement technology and if there is no dispersion in productivity, then a standard induces higher output of the dirty goods than the tax. In this case, a standard is better than a tax if the monopoly power in the dirty-goods sector is su¢ ciently strong. Third, if the abatement technology and productivity dispersion are both present, a tax is better than a standard if either productivity dispersion is su¢ ciently wide or the monopoly power in the dirty-goods sector is weak. These results illustrate the importance of productivity dispersion in designing environmental policies. They contribute to the debate on whether a non-market instrument such as the regulatory standard can be better than a market-based instrument, such as a tax, for achieving an emission target. JEL classi…cations: E60 Keywords: emission tax, emission standard, productivity dispersion, abatement. Li would like to acknowledge …nancial support by Shanghai Leading Academic Discipline Project, 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