Modeling Climate Policy Instruments in a Stackelberg Game with ...

10 2 METHODS AND ECONOMIC THEORY
by setting (inflexible) standards equal for all enterprises, command-and-control
instruments often cannot capture adequately the large differentials in abatement
costs across polluters and therefore fail to achieve the optimal economic outcome
(Goulder and Parry, 2008). 9
Bargaining (Coase Theorem) If property rights of polluting are well defined
and can be enforced – either in the way that the polluter has the right to his
polluting activity or the consumer has the right to a clean environment – both
parties will begin a bargaining process of paying abatement costs or compensation
for damages, respectively, resulting in a Pareto optimal level of pollution,
if transaction costs are neglected (Coase, 1960). For this outcome distribution
of property rights to polluter or consumer is irrelevant although distribution of
wealth will differ in favor of the party who has the property right (Mas-Colell
et al., 1995, pp. 356–357). Within the class of incentive based instruments, the
Coase solution of negotiations is also considered not to be feasible in practice
because of the immense effort of negotiations of millions of affected consumers
by environmental damages and thousands of polluting firms. Furthermore, the
Coase allocation considers compensation for the victims of pollution and thus it
sets negative incentives in individual defensive activities against environmental
damages (Cropper and Oates, 1992). Another important critique of the Coase
theorem mentions that the bargaining outcome indeed depends on assigning
the rights as such an allocation influences the income of both parties and hence
may influence level of compensation request or abatement payments (cf. Starrett,
2003, p. 113).
Effluent Taxes The idea of an effluent tax is to drop demand (here for emission
causing fossil resource extraction) due to a rising price. The environmental
tax can be charged on several places and products (Goulder and Parry, 2008):
on emissions causing the environmental damage, on the input factors that cause
the later emissions (e.g. fossil resource tax) or on the output of a production
process with emissions as by-product (e.g. fossil energy or final consumption
goods). A special and popular case of effluent tax is the Pigovian tax (Pigou,
1932) that is attached directly to the polluting activity on exactly that level
such that marginal benefits from reduced pollution equal marginal abatements
costs (Cropper and Oates, 1992). While this approach requires a quantification
of damages and benefits (cost-benefit approach), a modified emission tax could
be used by defining an environmental target (of concentration) that must not
be exceeded (cost-effectiveness approach). From a massbalance point of view,
Vatn (1998) shows that input taxation is equivalent to emission taxation if emissions
are homogenous and transaction costs of monitoring and enforcing are zero.
Schmutzler and Goulder (1997) state that under high monitoring costs, emission
tax may be suboptimal and output tax (or combination) may be a more
efficient second-best option. They show that output tax is more appropriate, (i)
the higher monitoring costs are, (ii) the lower the abatement options for emissions
are (i.e. the lower the carbon substitutability is), and (iii) the better the
substitutability of output is. Thus, several demand decreasing (output) taxes
are able to achieve an emission reduction but efficiency may be lower than that
9 However, in idealized world of perfect information for the regulator and no transaction
costs of information gathering and policy measures, the government could set a certain standard
perfectly adapted on individual circumstances of each firm.