Pollution control in a decentralized economy : which level of government should subsidize what in Brazil

Subsidies in Brazil essentially serve three purposes: (i) if assigned to the right level of government, they could reinforce the effectiveness of pollution taxes in reducing pollution; (ii) they offer an opportunity foradditional combinations of instruments and hence more flexibility in dealing with specific institutional characteristics of every state; and (iii) they can serve a purely"public relations"affect by showing that the federal government does not always rely on"sticks"but can also provide"carrots."The authors have four main messages of relevance to the Brazilian economy. First, carrots will not work without a stick. Subsidies of any type will not work without a coexisting pollution tax. Second, some carrots are better than others at achieving the government's objectives. In general, a state abatement subsidy is the more effective instrument to combine with a pollution tax. But when federal or state inspection capabilities are limited, monitoring subsidies may be an effective substitute. Third, increasing abatement subsidy rates can be counterproductive - tending to increase firm investment more than necessary and hence reduce the pollution tax base, while increasing subsidy costs. This can worsen the monitoring and inspection efforts and fiscal revenue. Finally, it is more effective to keep subsidy rates low if they are to be effective and sustainable and at the same time get the endorsement needed from state and federal fiscal administrations.