Bankruptcy Risk, Limited Liability and Imperfectly Enforced Emissions Taxes

Under reasonable conditions, noncompliance with an emissions tax has no effect on environmental outcomes or the efficient allocation of individual emissions control. Moreover, differences in individual tax violations are independent of firm-level differences. All of these desirable characteristics disappear when some firms under an emissions tax risk bankruptcy. The combination of imperfect enforcement, bankruptcy risk, and limited liability in bankrupt states produces an inefficient distribution of emissions control, higher aggregate emissions, and makes individual violations dependent on firm-level characteristics.