The Choice of Environmental Policy Instruments: Energy Efficiency and Redistribution

We analyse optimal environmental policies in a market that is vertically differentiated in terms of the energy efficiency of products. Considering energy taxes, subsidies to firms for investment in more eco-friendly products, and product standards, we are particularly interested in how distributional goals in addition to environmental goals shape the choice of policy instruments. Surprisingly, we find that an industry-friendly government levies an energy tax to supplement a lax product standard, but shies away from subsidies to firms. By contrast, a consumer-friendly government relies heavily on a strict product standard and in addition implements a moderate subsidy to firms, but avoids energy taxes.