International Side-payments to Improve Global Public Good Provision when Transfers are Refinanced through a Tax on Local and Global Externalities

Abstract

This paper discusses a tax-transfer scheme that aims to address the under-provision problem associated with the private supply of international public goods and to bring about Pareto optimal allocations internationally. In particular, we consider the example of the global public good ‘climate stabilization’, both in an analytical and a numerical simulation model. The proposed scheme levies Pigouvian taxes globally, while international side-payments are employed in order to provide incentives to individual countries for not taking a free-ride from the international Pigouvian tax scheme. The side-payments, in turn, are financed via environmental taxes. As a distinctive feature, we take into account ancillary benefits that may be associated with local public characteristics of climate policy. We determine the positive impact that ancillary effects may exert on the scope for financing side-payments via environmental taxation. A particular attractive feature of ancillary benefits is that they arise shortly after the implementation of climate policies and therefore yield an almost immediate payback of investments in abatement efforts. Especially in times of high public debt levels, long periods of amortization would tend to reduce political support for investments in climate policy.

Keywords:

• Ancillary benefits
• climate policy
• impure public goods
• environmental taxation
• international transfers

JEL CLASSIFICATIONS:

• Q38
• H23
• D62

Notes

¹On impure public goods also see Cornes and Sandler (1994, 1996). Impure public goods in the context of environmental protection have recently been discussed, e.g. by Rübbelke (2003) and Kotchen (2005, 2006). For an analysis of the existence and uniqueness of equilibria in the impure public good model see Kotchen (2007).

²Longo, Hoyos, and Markandya (2012) assess the willingness to pay (WTP) for ancillary and global benefits of climate protection policies in the Basque Country/Spain and their results show that WTP estimates are 53–73% higher when ancillary benefits are considered.

³This assumption is a simplification in the sense that some regional pollutants also spill over beyond national borders. For an analysis of sulphur emissions as transnational pollutants, see for example Finus and Tjøtta (2003).

⁴The case of one-sided spillovers has been analysed by Rübbelke and Sheshinski (2005).

⁵‘In the case of reciprocal consumption externalities, the common interpretation of the Pigouvian principle calls for taxes on the externality-creating commodities’ (Green & Sheshinski, 1976, p. 798).

⁶The link between emissions of pollutants and concentrations appears to fit such a relationship for SO₂ and fine particulate matter. See for example, Megaritis, Fountoukis, Charalampidis, Pilinis, and Pandis (2012).

⁷We can exclude the case of φ_1i=0 as a possible solution as that would imply X_i=0, which would require no consumption of the dirty private good and that is not a plausible case. Indeed with a Cobb-Douglas utility function that is not possible.

⁸The value of ω is still given by equation (24).