The Optimal Path of Energy and CO2 Taxes for Intertemporal Resource Allocation

Instead of carrying out a detailed technical analysis of the properties of an optimal path of the tax, we fourthly introduce in our base model the aspect that part of energy is wasted due to inefficient use of it. More effort in order to reduce the waste contributes to the conservation of the stock of fossil energy and prolongs the time span the CO2-fill capacity is exhausted. We show how the tax has to be modified to become a first-best instrument which is then in addition also an incentive to raise efforts (e.g. R&D expenditure on energy saving equipment). And fifthly, we take into account that fossil fuel is also the source of another air pollutant, SO2. The impact of SO2 on the environment (e.g. acid rain) can be mitigated by investing in abatement measures. We therefore introduce in addition to the energy tax a SO2 tax to cope with the damage from the accumulation of two stock pollutants. Although one could expect a complicated mix of tax interactions, the tax rules turn out to be very simple.