Public or Private Abatement? The Impact of Fiscal Policy Constraints

This paper extends the canonical literature on public incentives for firm-level abatement by introducing fiscal policy constraints and public abatement technologies. To increase acceptance of the emission tax policy, tax revenues are earmarked for public abatement or public good provision and no longer redistributed as welfare-neutral lump-sum transfers. The analysis reveals that partially substituting emission taxation with public abatement increases welfare in markets with imperfect competition. It is always optimal to cut the tax rate when public abatement is possible. This effect can be even more pronounced if the public sector invests in durable technologies such as afforestation. In this case, additional welfare gains are possible when public abatement is partially debt- funded. To service debt in later periods, the regulator should levy a higher emission tax rate as time progresses