Refunding Emissions Taxes: The Case For A Three-Part Policy

This paper examines theoretically whether by combining both output-based refunding and abatement expenditure-based refunding, it is possible to limit the negative consequences that a pollution tax implies for a polluting industry. We show that this is indeed the case by using a three-part policy where emissions are subject to a fee and where output and abatement expenditures are subsidized. When the industry is homogenous, it is possible to replicate the standard emission tax outcome by inducing a polluting firm to choose the production and emission levels obtained under any emission tax, without departing from budget balance. By construction, any polluter earns strictly more than under the standard tax alone without rebate, making this proposal more acceptable to the industry. When firms are heterogeneous, the refunding policy needed to replicate the standard emission tax outcome is personalized in the sense that at least the output subsidy should be type dependent and it is strictly preferred only from the industry’s point of view to a standard environmental tax. We also explore the implications of uniform three-part refunding policies for a heterogeneous industry.