NATIONAL BUREAU OF ECONOMIC RESEARCH
NATIONAL BUREAU OF ECONOMIC RESEARCH

Incidence and Environmental Effects of Distortionary Subsidies

Garth Heutel, David L. Kelly

NBER Working Paper No. 18924
Issued in March 2013
NBER Program(s):   EEE   PE

Government policies that are not intended to address environmental concerns can nonetheless distort prices and affect firms' emissions. We present an analytical general equilibrium model to study the effect of distortionary subsidies on factor prices and on environmental outcomes. We model an output subsidy, a capital subsidy, relief from environmental regulation, and a direct cash subsidy. In exchange for receiving subsidies, firms must agree to a minimum level of labor employment. Each type of subsidy and the employment constraint create both output effects and substitution effects on input prices and emissions. We calibrate the model to the Chinese economy, where government involvement affects emissions from both state-owned enterprises and private firms. Variation in production substitution elasticities does not substantially affect input prices, but it does substantially affect emissions.

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Document Object Identifier (DOI): 10.3386/w18924

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