Environmental and Resource Economics

, Volume 29, Issue 3, pp 337–360 | Cite as

Prices versus Quantities in a Second-Best Setting

  • Philippe Quirion


The choice between taxes and tradable permits has been independently analysed by two distinct research traditions. The first proceeds from Weitzman's partial equilibrium stochastic model and concludes that a tax should be preferred if the marginal abatement cost curve is steeper than the marginal environmental benefit curve. The second utilises deterministic general equilibrium models with pre-existing distortionary taxes. It concludes that non-revenue-raising instruments (e.g., grandfathered tradable permits) are costlier than revenue-raising ones (e.g., a tax on every unit of pollution or auctioned permits). To build a bridge between these two traditions, we introduce in Weitzman's model a positive cost of public funds due to pre-existing distortionary taxes. The tax admits a greater comparative advantage over the permits, as compared to Weitzman's classical result. Then, we assume that the regulated industry blocks any proposal that poses it too high an expected burden. This may require a transfer to firms, in the form of freely-allocated permits or lump-sum tax rebate. It turns out that if this acceptability constraint is binding, then the comparative advantage of taxes over permits is still reinforced. Quantitatively, even if the marginal benefit function is 50% more steeply sloped than the marginal cost function, the price instrument should be preferred. We also compare the expected net benefit of these two instruments to a contingent instrument which leads to the ex post optimum. The superiority of the contingent instrument over the quantity one is higher than in first-best.

environmental taxes policy choice second best tradable permits uncertainty 


Unable to display preview. Download preview PDF.

Unable to display preview. Download preview PDF.


  1. Asplund, M.(1999),'Risk-Averse Firms in Oligopoly ',Gothenburg University Working Paper.Google Scholar
  2. Baumol, W.and W. Oates (1988),The Theory of Environmental Policy,2nd ed.,Cambridge: Cambridge University Press.Google Scholar
  3. Boemare, C. and P. Quirion (2002),'Implementing Greenhouse Gas Trading in Europe: Lessons from Economic Literature and International Experiences',Ecological Economics, 43,213-230.Google Scholar
  4. Bovenberg, L. and L. Goulder (2000),Neutralising the Adverse Industry Impacts of CO2 Abatement Policies:What Does It Cost?,Fondazione Eni Enrico Mattei Working Paper 68.Google Scholar
  5. Bovenberg, L. and L. Goulder (2001),Environmental Taxation and Regulation,NBER Working Paper 8458,NBER, Cambridge,Massachusetts.Google Scholar
  6. Burtraw, D.,K. Palmer, R. Bharvirkar and A. Paul (2001),The Effect of Allowance Allocation on the Cost of Carbon Emission Trading,Resources for the Future Discussion Paper 01-30.Google Scholar
  7. Climate Action Network Europe (2001),Emission Trading in the EU,December,Brussels.Google Scholar
  8. Collinge, R. and W. Oates (1980),'Efficiency in Pollution Control in the Short and the Long Run:A System of Rental Emissions Permits ',Canadian Journal of Economics 15,346-354.Google Scholar
  9. Ekins, P.(1999),'European Environmental Taxes and Charges:Recent Experience,Issues and Trends',Ecological Economics 31,39-62.Google Scholar
  10. Ekins, P. and S. Speck (1999),'Competitiveness and Exemptions from Environmental Taxes in Europe',Environmental and Resource Economics 13,369-396.Google Scholar
  11. Fullerton, D. and G. Metcalf (2001),'Environmental Controls,Scarcity Rents,and Pre-Existing Distortions',Journal of Public Economics 80,249-267.Google Scholar
  12. Goulder, L.(1995),'Environmental Taxation and the Double Dividend:A Reader 's Guide', International Tax and Public Finance 2(2),157-183.Google Scholar
  13. Goulder, L., I. Parry and D. Burtraw (1999a),'Revenue-Raising vs.Other Approaches to Environmental Protection:The Critical Significance of Pre-Existing Tax Distortions ', RAND Journal of Economics 28(4),708-731.Google Scholar
  14. Goulder, L., I. Parry, R. Williams and D. Burtraw (1999b),'The Cost-Effectiveness of Alternative Instruments for Environmental Protection in a Second-Best Setting',Journal of Public Economics 3(72),329-360.Google Scholar
  15. Greenpeace (2000),Cheating the Kyoto Protocol:Loopholes Undermine Environmental Effectiveness,November,Amsterdam.Google Scholar
  16. Hammar, H. and A. Lo ¨fgren (2000),The Determinants of Sulphur Emissions from Oil Con-sumption in Swedish Manufacturing Industry;1976-1995,Working Paper,May,Gothenburg University, Sweden.Google Scholar
  17. Helioui, K.(1997),Double dividende d 'une e ´cotaxe en pre ´sence de fluctuations conjoncturelles et de rigidite ´s de l 'emploi,CIRED Working Paper,Nogent-sur-Marne, France.Google Scholar
  18. Hourcade, J.-C.(1994),'Economic Issues and Negotiation on Global Environment',in C. Carraro ed., Trade;Innovation,Environment.Dordrecht,The Netherlands: Kluwer Academic Publishers.Google Scholar
  19. Intergovernmental Panel on Climate Change (2001),'Global, Regional, and National Costs and Co-benefits of Mitigation',Climate Change 2001:Mitigation-Third Assessment Report of Working Group III,Chapter 8.Cambridge: Cambridge University Press.Google Scholar
  20. Ireland, N.(1977),'Ideal Prices vs.Prices vs.Quantities',Review of Economic Studies 44(1), 183-186.Google Scholar
  21. Jensen, J. and T. Rasmussen (2000),'Allocation of CO 2 Emissions Permits:A General Equilibrium Analysis of Policy Instruments ',Journal of Environmental Economics and Management 40,11-36.Google Scholar
  22. Kehoane, N.,R. Revesz and R. Stavins (1998),'The Positive Political Economy of Instrument Choice in Environmental Policy',in P. Portney and R. Schwab eds.,Environmental Economics and Public Policy,London: Edward Elgar.Google Scholar
  23. Kopp, R.,et al.(1999),Domestic Early Action:A Mandatory,Comprehensive Permit Trading System,Mimeo,Resources for the Future,Washington,DC.Google Scholar
  24. Lee, D.R.and Misiolek, W.S.(1986),'Substituting Pollution Taxation for General Taxation: Some Implications for Efficiency in Pollution Taxation ',Journal of Environmental Economics and Management 13,338-347.Google Scholar
  25. Le ´vêque, F.(ed.)(1996),Environmental Policy in Europe-Industry,Competition and the Policy Process,London: Edward Elgar.Google Scholar
  26. Mumy, G.(1980),'Long-Run Efficiency and Property Rights Sharing for Pollution Control',Public Choice 35,59-74.Google Scholar
  27. NHO (Confederation of Norwegian business and industry)(2001),Meeting the Kyoto Protocol Commitments-Summary-Domestic Emissions Trading Schemes,January,Oslo,Norway.Google Scholar
  28. Nichols, A.L.(1984),Targeting Economic Incentives for Environmental Protection.Cambridge, Massachusetts: MIT Press.Google Scholar
  29. Parry, I.(1995),'Pollution Taxes and Revenue Recycling',Journal of Environmental Economics and Management 29,S64-S77.Google Scholar
  30. Parry, I.(1997),'Environmental Taxes and Quotas in the Presence of Distorting Taxes in Factor Markets',Resource and Energy Economics 19,203-220.Google Scholar
  31. Parry, I., R. Williams and L. Goulder (1999),'When Can Carbon Abatement Policies Increase Welfare?The Fundamental Role of Distorted Factor Markets',Journal of Environmental Economics and Management 37,52-84.Google Scholar
  32. Pezzey, J.(1992),'The Symmetry between Controlling Pollution by Price and Controlling It by Quantity',Canadian Journal of Economics 25(4),983-991.Google Scholar
  33. Pizer, W.(1999),'The Optimal Choice of Climate Change Policy in the Presence of Uncertainty',Resource and Energy Economics 21(3-4),255-287.Google Scholar
  34. Roberts, M. and M. Spence (1976),'Uncertainty and the Choice of Pollution Control Instruments',Journal of Public Economics 5,April/May,193-208.Google Scholar
  35. Sandmo, A.(1975),'Optimal Taxation in the Presence of Externalities ',Swedish Journal of Economics 77,86-98.Google Scholar
  36. Scho ¨b, R.(1996),'Choosing the Right Instrument-the Role of Public Revenues for Environmental Policy',Environmental and Resource Economics 8,399-416.Google Scholar
  37. Stavins, R.(1996),'Correlated Uncertainty and Policy Instrument Choice',Journal of Environmental Economics and Management 30,218-232.Google Scholar
  38. Tietenberg, T.(2002),'The Tradable Permits Approach to Protecting The Commons:What Have We Learned?',Fondazione Eni Enrico Mattei Working Paper 36.Google Scholar
  39. Unold, W. and T. Requate (2001),Pollution Control by Options Trading under Imperfect Information,EAERE Conference,28-30 June, Southampton, UK.Google Scholar
  40. Weitzman, M.(1974),'Prices vs.Quantities',Review of Economic Studies 41(4),447-491.Google Scholar

Copyright information

© Kluwer Academic Publishers 2004

Authors and Affiliations

  • Philippe Quirion

There are no affiliations available

Personalised recommendations