When Can Carbon Abatement Policies Increase Welfare? The Fundamental Role of Distorted Factor Markets

Ian W. H. Parry, Roberton C. Williams III, Lawrence H. Goulder

NBER Working Paper No. 5967
Issued in March 1997
NBER Program(s):   PE   EEE

This paper employs analytical and numerical general equilibrium models to assess the efficiency impacts of two policies to reduce U.S. carbon emissions -- a carbon tax and a carbon quota -- taking into account the inter- actions between these policies and pre-existing tax distortions in factor markets. We show that tax interactions significantly raise the costs of both policies relative to what they would be in a first-best setting. In addition, we show that these interactions put the carbon quota at a signficant efficiency disadvantage relative to the carbon tax: the costs of reducing emissions by 10 % are more than three times higher under the carbon quota than than under the carbon tax. This disadvantage reflects the inability of the quota policy to generate revenue that can be used to reduce pre-existing dis- tortionary taxes. Indeed, second-best considerations severely limit the potential of a carbon quota to general overall efficiency gains. Under our central estimates, a non-auctioned carbon quota (or set of grandfathered carbon emissions permits) cannot increase efficiency unless the marginal benefits from avoided future climate change are at least $25 per ton of carbon abatement. Most estimates of these marginal environmental benefits are well below $25 per ton. Thus, our analysis suggests that any carbon abatement by way of a non-auctioned quota will be efficiency-reducing. In contrast, a revenue-neutral carbon tax is found to be efficiency-improving so long as marginal environmental benefits are positive.

download in pdf format
   (1716 K)

email paper

Machine-readable bibliographic record - MARC, RIS, BibTeX

Document Object Identifier (DOI): 10.3386/w5967

Published: Parry, Ian W. H., Roberton C. Williams and Lawrence H. Goulder. "When Can Carbon Abatement Policies Increase Welfare? The Fundamental Role Of Distorted Factor Markets," Journal of Environmental Economics and Management, 1999, v37(1,Jan), 52-84. citation courtesy of

Users who downloaded this paper also downloaded* these:
Goulder, Parry, Williams, and Burtraw w6464 The Cost-Effectiveness of Alternative Instruments for Environmental Protection in a Second-Best Setting
Poterba w3649 Tax Policy to Combat Global Warming: On Designing a Carbon Tax
Goulder and Mathai w6494 Optimal CO2 Abatement in the Presence of Induced Technological Change
Hassett, Mathur, and Metcalf w13554 The Incidence of a U.S. Carbon Tax: A Lifetime and Regional Analysis
Bovenberg and Goulder Neutralizing the Adverse Industry Impacts of CO2 Abatement Policies: What Does It Cost?
NBER Videos

National Bureau of Economic Research, 1050 Massachusetts Ave., Cambridge, MA 02138; 617-868-3900; email:

Contact Us