Intra-Industry Reallocations and Long-run Impacts of Environmental Regulations

We investigate the long-run impact of environmental regulations on the intra-industry distribution of firm-level productivity and the resulting aggregate variables. In a general-equilibrium model that accounts for endogenous entry/exit of heterogeneous firms, neither the average productivity of firms nor the mass of firms is independent of the choice of policy instruments (i.e. emissions tax vs. emissions trading) or permit allocation rules. The equilibrium price of permits under emissions trading is lower than the emissions tax rate that would support the same aggregate emissions. An incomplete emissions market results in a net increase in combined aggregate emissions.