Environmental Regulation and Policy Design: The Impact of the Regulator?s Ecological Conscience on the Tax Setting Process

This paper presents an analysis of environmental policy in imperfectly competitive markets. We investigate how environmental taxes should be optimally levied in a precommitment policy game and their effects on social welfare. The paper also examines the potential impacts of the regulator?s environmental conscience on policy setting. We start the analysis with a benchmark model where all players are environmentally dirty in the marketplace. We then extend the model to the case in which the market is composed of a mix of dirty and clean strategic players. We show that, in both cases, the regulator must necessarily trade off between regulation of environmental quality and the industry production inefficiency problems. Furthermore, the results show how higher levels of concern for environmental issues outweigh the under taxation problem that arises in order to avoid further reductions in welfare. Finally, we show that the existence of clean players produces positive social externalities. Under an ex ant environmental policy game, higher social welfare outcomes are possible.