Pollution Control Policy: A Dynamic Taxation Scheme

In this paper we investigate a dynamic setting of environmental taxation, for which the government imposes a tax rate in order to internalize externalities caused by polluting firms. The basic model consists of the intertemporal maximization problem for an additively separable utility which is subject to the pollution accumulation constraint. We analyze some various aspects of the same setting such as the leader-follower, the social planning and the simultaneous move game. The model is very simple and has some similarities with capital taxation models. The crucial variables of the model are the tax rate as a control and the pollution stock as a state. We discuss a scheme in which polluters adopt Markovian emission strategies with respect to the flows, and the tax rate imposed is, in the most cases, a constant depending on the discount rate. Moreover, computing the time paths for the control and state variables, the welfare index analysis, that follows, reveals substantial inefficiencies caused by th e leader-follower setting, compared with the social planning optimal control setting.