W3 - Incentive based mechanisms for regulating pollution: Price rationing

Question 1

Define a Pigouvian fee - why is it different to a tax

Answer 1

Fee paid to government per unit of pollution equal to aggregate marginal damage caused by the pollution when evaluates at the socially efficient point of pollution

Tax is distortionary as they lead to inefficiency eg. income tax whereas Pigouvian fee delivers the Samuelson condition

Question 2

Draw the graph of the Pigouvian fee approach with the marginal damage curves of 2 separate entities

Answer 2

okay

Question 3

How should the revenue raised from Pigouvian fee’s be used? What are the short and long run impacts of victim compensation?

Answer 3

Could be used towards general budget, reducing distortionary taxes (double dividend), or to compensate victims.

When victims can do nothing to influence pollution levels, compensation does not change polluters behaviour.

Short: No pollution quantity or efficiency change, but does address equity

Long: Compensation will attract more victims, leading to greater social costs (spiral of compensation)

Question 4

When there are multiple polluters, how much pollution should each firm generate and how should the Pigouvian fee be set?

Answer 4

Impose the same Pigouvian fee on all firms to achieve the equimarginal principle (same marginal abatement cost)

Question 5

What are the 5 conditions for Pigouvian fees to work?

Answer 5

1) Uniformly mixed pollutant - if location matters, vary the fee
2) Single pollution or no synergistic effects - if synergistic, harm is underestimated, if multiple, need different fees one each
3) Pollution can be monitored
4) Government knows the SMD and MB curves well or can adapt the fee rate
5) Market cannot be monopoly, or else under pollution will happen

Question 6

What are the different short and long run effects of imposing a tax vs a subsidy?

Answer 6

Short:
Tax - Forces least efficient and most highly polluting firms to leave (good)
Subsidy - Allows inefficient firms to run, keeping them in the market (bad)

Long:
Tax - hard to cover costs, more firms leave
Subsidy - pollution reduction = profit, firms join to benefit, increasing total pollution even if pollution per firm is lower

Tax better but politically hard to sell

Question 7

Give 2 reasons subsidies are undesirable aside from the inefficiency in the market short and long term.

Answer 7

Subsidies are usually funded by a distortionary tax

Do not allow the market to communicate the true cost of the product being consumed

Question 8

What happens if you apply Pigouvian fees to a monopoly market? Describe the two cases

Answer 8

Pigouvian fee needs competitive markets - undesirable consequences if applied to monopoly.

1) Monopoly in output market but many polluters

2) Sole polluter eg. local chemistry plant - concerning

Question 9

Draw the graph of impact of tax on a monopoly

Answer 9

Okay

Question 10

What are the 3 tax instruments used in environmental policy?`

Answer 10

1) Emissions taxes - tax on pollution measured
2) Product taxes/charges - Levied on actual product or inputs, used when too costly to measure pollution eg. plastic bag tax
3) User charges - payments related to use of public services eg. sewage disposal

Question 11

Give the example of the Norwegian carbon tax

Answer 11

• Covered the non EU ETS carbon emission, roughly 60% of energy related emissions.
• Generated 2% of total tax revenue
• GDP grew by 23%, emissions by 4% - showed increase in GDP doesn’t need increase in emissions
• Incentive to tech innovation
• Tax working in Norway but not other Scandinavian countries

Question 12

What are the challenges of an environmental tax?

Answer 12

1) MS and MD curve unknown so setting optimal level is difficult
2) Politically unpopular as reduces international competitiveness
1) + 2) means tax rate set too low so minimal impact

3) low tax rate + low elasticity means consumers demand basically the same amount
So overall tax does not emit the intended signal