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Subsidizing Non-Polluting Goods vs. Taxing Polluting Goods for Pollution Reduction

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Abstract

Pigovian taxes on polluters are politically unpopular, but subsidies for non-polluting sources are politically attractive. This paper presents a linear demand and supply model and numerical example to explore the trade-offs between taxing polluting sources of a good versus subsidizing non-polluting sources of the same good. While the model (along with the associated numerical example) shows the optimality of Pigovian taxes, it also shows how much welfare is reduced if subsidies for nonpolluters are employed instead. Further, it shows the optimal tax, given any level of subsidy and the optimal subsidy, given any level of tax.

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Notes

  1. See, for example, Galitano and Yoder (2010), Parry (1998), Sandmo (1975), and Metcalf (2009).

  2. As Main (2010) shows, the MEC per unit of output can be reduced by incurring some costs. Taxing the pollution directly by means of an effluent charge, rather than employing a tax on the output of the good, would be more efficient. In this paper, that possibility is assumed away for simplicity.

  3. Parry (1998) points out that a more complete analysis would take account of the fact that subsidies must be paid for by distortionary taxes.

  4. Policy makers are assumed to know the demand for the good and the supply curves of the two sources of supply, as well as the MEC for the polluting source.

References

  • Galitano, G. I., & Yoder, J. K. (2010). An integrated tax-subsidy policy for carbon emission reduction. Resource and Energy Economics, XXXII, 310–326.

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  • Main, R. S. (2010). Simple pigovian taxes vs. emission fees to control negative externalities: a pedagogical note. The American Economist, LV(2), 104–110.

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  • Metcalf, G. E. (2009). Tax policies for low-carbon technologies. National Tax Journal, LXII(3), 519–533.

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  • Parry, I. W. H. (1998). A second best analysis of environmental subsidies. International Tax and Public Finance, V(2), 153–170.

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  • Sandmo, A. (1975). Optimal taxation in the presence of externalities. The Swedish Journal of Economics, LXXVII(1), 86–98.

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Acknowledgements

I wish to thank my colleagues, William Rieber and Peter Grossman, as well as Robert Terpstra and Haney Scott, for helpful comments and encouragement.

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Authors and Affiliations

  1. Department of Economics, Law and Finance, Butler University, 4600 Sunset Avenue, Indianapolis, IN, 46208, USA

    Robert S. Main

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  1. Robert S. Main
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Correspondence to Robert S. Main.

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Main, R.S. Subsidizing Non-Polluting Goods vs. Taxing Polluting Goods for Pollution Reduction. Atl Econ J 41, 349–362 (2013). https://doi.org/10.1007/s11293-013-9370-6

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  • DOI: https://doi.org/10.1007/s11293-013-9370-6

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