Regulatory Choice with Pollution and Innovation
This paper develops a simple model of a polluting industry and an innovating firm. The polluting industry is faced with regulation and costly abatement. Regulation may be taxes or marketable permits. The innovating firm invests in R&D and develops technologies which reduce the cost of pollution abatement. The innovating firm can patent this innovation and use a licensing fee to generate revenue. In a world of certainty, the first best level of innovation and abatement can be supported by either a pollution tax or a marketable permit. However, the returns to the innovator from innovation are not the same under the two regimes. A marketable permit system allows the innovator to capture all of the gains to innovation; a tax system involves sharing the gains of innovation between the innovator and the polluting industry.
Research assistance from Valentin Shmidov is gratefully acknowledged. Comments from Don Fullerton, Sasha Golub, Rob Williams, Kerry Smith, Barry Nalebuff, Nat Keohane and several anonymous referees have been appreciated. Research supported in part by the University of California Center for Energy and Environmental Economics (UCE3). The views expressed herein are those of the author and do not necessarily reflect the views of the National Bureau of Economic Research.
Regulatory Choice with Pollution and Innovation, Charles D. Kolstad. in The Design and Implementation of U.S. Climate Policy, Fullerton and Wolfram. 2012