Reconsidering the choice of market based environmental policy instruments: rent creation and political influence

The establishment of new environmental regulation, such as emissions taxes and tradable pollution permit markets, create rents that can be captured through a process of socially wasteful rent seeking. In this paper, we create a framework that compares social welfare under alternative market-based environmental policy instruments when agents lobby for the contestable rent. We show revenue raising mechanisms (e.g. pollution permit auction, emissions taxes) are not always preferred over non-revenue raising instruments (e.g. freely allocated pollution permits). We find the choice of instrument depends on the size of the revenue recycling effect and how the rent is shared among members of interest groups.