Taxes And Trading Versus Intensity Standards: Second-Best Environmental Policies With Incomplete Regulation (Leakage) Or Market Power

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Executive Summary

This paper investigates whether an emissions tax is the best policy in the presence of incomplete regulation (leakage) or market power by analyzing an intensity standard regulating emissions per unit of output. With no other market failures, an intensity standard is indeed inferior, although combining it with consumption tax eliminates this inferiority. For incomplete regulation, I show that under certain conditions an intensity standard can dominate any emissions tax. This dominance persists even with the addition of a consumption tax, which ameliorates output distortions and can sometimes help the intensity standard attain the first best.

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