Emissions intensity and choice of policy instrument with asymmetric information and growth

abstract

The advantages and disadvantages of environmental policies based on emission intensity targets have been widely discussed. Emission tax policies tend to be ranked ahead of emission intensity instruments due, in part, to the former's incentive effects. A comparison of the effect that emission intensity targets and emission taxes have on abatement costs in a world of asymmetric information is worth exploring. This analysis suggests that in terms abatement costs and the nature of the errors due to asymmetric information, a tax on emission has no absolute advantage over an emissions intensity policy in the short run and given the qualitative nature of the welfare losses in both cases, an emissions target policy may be preferred. Furthermore, an emission intensity target may be an appropriate instrument when growth in output of polluting firms is expected.

Keywords:

• emission intensity
• emission cap
• imperfect information
• emission tax

Acknowledgements

I wish to thank the Journal's reader who made very helpful and instructive comments on an earlier draft of this paper.

Disclosure statement

No potential conflict of interest was reported by the author.

Notes

1. A firm or industry responding to the intention of government to control emissions will make the case that restricting emissions will be costly, leading to higher prices, reduced output and perhaps job loss. An understanding of the magnitude of such costs may be important in the final design of a policy. While optimal policy would call for accounting for any and all externalities, in practice this may not be possible.

2. China utilises carbon emission intensity as a country-wide goal in its long-term climate change policy. ‘The 12th Five-Year Plan (2011–2015)’ was published in 2011. It demands that CO₂ emission intensity in this period must be reduced by 17% compared with 2010, see Wang et al. (2012). For a detailed description of the Canadian government's emission intensity strategy, see http://www.ogilvyrenault.com/en/resourceCentre_978.htm. In the United States, the Environmental Protection Agency recently proposed to limit the emission of pounds of carbon dioxide per megawatt-hour of electricity production (The Economist 2013).

3. Abatement uncertainty with respect to tax levies is explored in Hoel (1998).

4. It is possible in this case that an emission tax rate set on the basis of the perceived abatement cost function and true damage function could result in the polluter having to eliminate all emissions to avoid the tax.

5. For example, the 1992 Earth Summit (Rio Conference) declared that, ‘In order to protect the environment, the precautionary approach shall be widely applied by States according to their capabilities. Where there are threats of serious or irreversible damage, lack of full scientific certainty shall not be used as a reason for postponing cost-effective measures to prevent environmental degradation’. Another similar definition is ‘if a threat of serious or irreversible damage to the environment or human health exists, a lack of full scientific knowledge about the situation should not be allowed to delay containment or remedial steps if the balance of potential costs and benefits justifies enacting them’.

6. For an excellent discussion of irreversible environmental damage in this context, see Pindyck (2007).

7. As McKitrick (2011, p. 71) points out, ‘….benefits and costs may be uncertain, and may depend on characteristics of the future of which we only have probabilistic information today’.