Energy taxes and endogenous technological change

This paper studies the effects of a tax on energy use in a growth model where market structure is endogenous and jointly determined with the rate of technological change. Because this economy does not exhibit the scale effect (a positive relation between TFP growth and aggregate R&D), the tax has no effect on the steady-state growth rate. It has, however, important transitional effects that give rise to surprising results. Specifically, under the plausible assumption that energy demand is inelastic, there may exist a hump-shaped relation between the energy tax and welfare. This shape stems from the fact that the reallocation of resources from energy production to manufacturing triggers a temporary acceleration   of TFP growth that generates a √√-shaped time profile of consumption. If endogenous technological change raises consumption sufficiently fast and by a sufficient amount in the long run, and households are sufficiently patient, the tax raises welfare despite the fact that—in line with standard intuition—it lowers consumption in the short run.