Environmental Policy and Growth when Inputs are Differentiated in Pollution Intensities

I show that environmental policy affects the cross sectoral allocation of demand and output if intermediate goods are differentiated according to their pollution intensity. When innovations are environmental friendly, a tax on emissions skews demand towards new goods, which are the most productive. In this case along a balanced growth path the tax on emissions is increasing to keep the market share of innovations constant. Furthermore, comparing balanced growth paths I find that an increase in the burden of green taxes lowers output on impact but increases the rate of growth of the economy, because it fosters innovation.