Designing Environmental Instruments to Finance Agricultural Intensification Through the Clean Development Mechanism: Direct Cost Subsidy Versus Tax Cut Under Asymmetric Information

Abstract

Various agreements addressing climate change plead for the adoption of innovative green technologies to reduce production of greenhouse gases responsible for global warming. Yet, the most successful instrument so far, the Clean Development Mechanism (CDM) is at pains to succeed in small, developing countries facing sustainable development problems like food security. Worse, while the CDM succeeded in financing agricultural projects, few are funded in small, developing countries.A tax cut is one innovative financial scheme that many countries enact in their investment code to promote environmentally sound technologies. Tax cuts return a portion of investment costs to firms that implement green innovations, which ultimately reduces investment costs and so adds to their net benefits. We compare this scheme to a direct cost subsidy designed to offer firms access to capital at a lower interest, for their capacities to boost the use of CDM in agriculture. This paper shows that the narrow scope of tax cuts compared to direct cost subsidies make corporate tax relief inadequate for the needs of developing countries. We also show that while both schemes are equally efficient under perfect conditions and asymmetric information, the direct cost subsidy is more appropriate to further environmental and sustainability goals like food security in developing countries where informational problems are pervasive. Empirical results support these results (JEL: D61, D82, G21, O13, Q01, Q54, Q55.)