Policy Design in the Context of Multiple Pollutants and Regulators

We consider firms combining variable inputs and heterogeneous capital goods. Input use may cause simultaneous flow and stock externalities (e.g., air pollution/ climate change). Regulatory bodies typically develop separate policies for each externality but do not recognize that many externalities are interrelated. The paper determines the socially optimal coordinated taxation scheme based on a two-phase optimization approach. It 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 depending 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 between coordinated and non-coordinated taxes is in the range of 9 – 12%