The cost-effectiveness of alternative instruments for environmental protection in a second-best setting
This paper employs analytical and numerical general equilibrium models to examine the significance of pre-existing factor taxes for the costs of pollution reduction under a wide range of environmental policy instruments. Pre-existing taxes imply significantly higher abatement costs for every instrument considered, but the cost-impact of such taxes differs sharply across instruments. Prior taxes can eliminate the cost-advantage of market-based instruments (emissions taxes and permits) over technology mandates or performance standards, particularly if the former policies fail to generate revenues and use the revenues to finance cuts in the prior distortionary taxes. The cost differences between instruments are highly sensitive to the extent of pollution abatement: for most policies, abatement costs converge to the same value as pollution abatement approaches 100 percent.