Abstract

We consider firms that combine variable inputs and capital goods that embody different technologies. Input use may cause simultaneously flow and stock externalities (e.g., air pollution/ climate change). Regulatory bodies tend to respond to this challenge by developing separate policies for each externality but do not recognize that many externalities are interrelated. Based on a two-phase optimization approach formulated in the context of CO₂ emissions, the paper determines the socially optimal coordinated taxation scheme. It also demonstrates that the presence of one externality magnifies the efficiency losses of the other. Therefore, non-coordinated taxation of the two externalities leads to over taxation. The analysis also defines the socially optimal taxation scheme of a second externality when the regulation/taxation of the first externality is unalterable. If the CO₂ emissions for a given unit of input depend on the employed technology, optimal policies require technology-differentiated tax schemes. Improving the precision of the CO₂ footprint of the variable inputs as a function of the employed technology not only helps to improve the implementation of a technology differentiated taxation scheme but most likely also the perception of social justice and consequently public acceptance of carbon taxes. A numerical example based on data from the literature illustrates that the difference of coordinated and non-coordinated taxes is in the range of 9 – 12%.

Co-author : Angels Xabadia and David Zilberman

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