11. Corrective Tax vs Pollution Permits
Based on Dr. Said's slide p. 57 (Mankiw comparison)
Side-by-Side Comparison
Corrective Tax
- Sets the PRICE of pollution (horizontal line)
- Quantity of pollution determined by market (where demand intersects tax line)
- Government knows the right price (MEC) but not the exact quantity
- Revenue goes to government
Tradable Pollution Permits
- Sets the QUANTITY of pollution (vertical line)
- Price of pollution determined by market (where supply intersects demand)
- Government knows the right quantity but not the exact price
- Permits can be traded - efficient firms profit, dirty firms pay
Key insight: Both achieve the same result when the government has perfect information. They differ when there's uncertainty about the demand for pollution rights.
When to Use Tax vs Permits?
Use tax when: The damage per unit of pollution is well-known (can set correct MEC), but the level of pollution is uncertain.
Use permits when: The target pollution level is well-known (e.g., scientific evidence says emissions must be below X), but the cost of achieving it is uncertain.
In practice, many countries use a combination: carbon taxes for some sectors, cap-and-trade (permits) for others.