Modeling environmental policy with and without abatement substitution: A tradeoff between economics and environment?

This study proposes a set of optimal emission taxes that could be used to fully internalize environmental externalities. Carbon fees are computed for low-income economies, lower-middle-income economies, upper-middle-income economies, high-income economies, China and the United States. Subsequently, the implementation of these emission taxes is evaluated under two different scenarios; one assuming abatement substitution and the other relaxing this assumption. Estimated damages and abatement from various sectors lie between 0.0003 to 0.021 and 0.001 to 0.012 lb per dollar output respectively. Optimal pollution taxes per dollar output range as high as 2.8% for heavy manufacturing in the high income countries, and as low as 0.01% in the service sectors of the low income countries. On the impacts of these taxes, the study produces evidence that, whether abatement substitution is present or not, production in low-income economies would be less adversely affected due to carbon taxes relative to high-income countries. In addition, the emissions taxes reduce environmental damages by nearly 50% in all regions. Worldwide welfare gains from internalizing negative externalities when no abatement substitution is present is about three times the welfare gains in the presence of abatement substitution. Although these results imply a sort of tradeoff between the economics of production and environment, improved environmental benefits due to carbon taxes seem to outweigh the deterioration in economic activities; and as such, welfare improves in general.