Environmental Policy à la Carte:Letting Firms Choose their Regulation

Environmental policy often has to be devised under informational constraints,like uncertainty and asymmetric information. We consider an environmentalpolicy that aims at reducing the welfare losses caused by asymmetricinformation while being sufficiently simple for implementation. Inthis policy, firms can choose between being regulated with an emission taxor a permit market. This serves as a screening device; the firms reveal privateinformation by choosing an instrument. We show that such a menuof policy options improves upon conventional environmental policy. Furthermore,the optimal policy is simple and thus easily implementable. Theapproach is also theoretically interesting, because the simultaneous use ofprice- and quantity-based instruments induces an asymmetry into the pricesversus-quantities decision compared to Weitzman’s criterion. Especially,there can be an optimal pooling equilibrium where all firms choose the tax,but it is never optimal that all firms participate in permit trading.