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Robust Dynamic Optimal Taxation and Environmental Externalities

Author

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  • Ted Temzelides

    (Rice University)

  • Borghan Narajabad

    (Federal Reserve)

Abstract

We study a dynamic stochastic general equilibrium model where agents are concerned about model uncertainty regarding climate change. An externality from greenhouse gas emissions adversely affects the economys capital stock. We assume that the mapping from climate change to damages is subject to uncertainty, and we adapt and use techniques from robust control theory in order to study efficiency and optimal policy. We obtain a sharp analytical solution for the implied environmental externality, and we characterize dynamic optimal taxation. A small increase in the concern about model uncertainty can cause a significant drop in optimal energy extraction. The optimal tax which restores the social optimal allocation is Pigouvian. Under more general assumptions, we develop a recursive method and solve the model computationally. We find that the introduction of uncertainty matters qualitatively and quantitatively. We study optimal output growth in the presence and in the absence of concerns about uncertainty and find that these can lead to substantially dfferent conclusions.

Suggested Citation

  • Ted Temzelides & Borghan Narajabad, 2014. "Robust Dynamic Optimal Taxation and Environmental Externalities," 2014 Meeting Papers 59, Society for Economic Dynamics.
  • Handle: RePEc:red:sed014:59
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    References listed on IDEAS

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    Cited by:

    1. Anderson, Evan W. & Brock, William & Sanstad, Alan H., 2016. "Robust Consumption and Energy Decisions," 2017 Allied Social Sciences Association (ASSA) Annual Meeting, January 6-8, 2017, Chicago, Illinois 250117, Agricultural and Applied Economics Association.
    2. Rick Van der Ploeg & Armon Rezai, 2015. "Intergenerational Inequality Aversion, Growth and the Role of Damages: Occam's rule for the global tax," Economics Series Working Papers OxCarre Research Paper 15, University of Oxford, Department of Economics.
    3. Armon Rezai & Frederick Van der Ploeg, 2016. "Intergenerational Inequality Aversion, Growth, and the Role of Damages: Occam's Rule for the Global Carbon Tax," Journal of the Association of Environmental and Resource Economists, University of Chicago Press, vol. 3(2), pages 493-522.
    4. Li, Zhe & Sun, Jianfei, 2015. "Emission taxes and standards in a general equilibrium with entry and exit," Journal of Economic Dynamics and Control, Elsevier, vol. 61(C), pages 34-60.
    5. Lemoine, Derek & Traeger, Christian P., 2016. "Ambiguous tipping points," Journal of Economic Behavior & Organization, Elsevier, vol. 132(PB), pages 5-18.
    6. Ngo Van Long, 2019. "Managing, Inducing, and Preventing Regime Shifts: A Review of the Literature," CESifo Working Paper Series 7749, CESifo.

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    • N10 - Economic History - - Macroeconomics and Monetary Economics; Industrial Structure; Growth; Fluctuations - - - General, International, or Comparative

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