Optimal Taxes on Fossil Fuel in General Equilibrium

Abstract

We analyze a dynamic stochastic general-equilibrium (DSGE) model with an externality through climate change from using fossil energy. A central result of our paper is an analytical derivation of a simple formula for the marginal externality damage of emissions. This formula, which holds under quite plausible assumptions, reveals that the damage is proportional to current GDP, with the proportion depending only on three factors: (i) discounting, (ii) the expected damage elasticity (how many percent of the output flow is lost from an extra unit of carbon in the atmosphere), and (iii) the structure of carbon depreciation in the atmosphere. Very importantly, future values of output, consumption, and the atmospheric CO2 concentration, as well as the paths of technology and population, and so on, all disappear from the formula. The optimal tax, using a standard Pigou argument, is then equal to this marginal externality. The simplicity of the formula allows the optimal tax to be easily parameterized and computed. Based on parameter estimates that rely on updated natural-science studies, we find that the optimal tax should be a bit higher than the median, or most well-known, estimates in the literature. We also show how the optimal taxes depend on the expectations and the possible resolution of the uncertainty regarding future damages. Finally, we compute the optimal and market paths for the use of energy and the corresponding climate change.

Managing Climate Change Under Uncertainty: Recursive Integrated Assessment at an Inflection Point

“…We here describe the benchmark approach to integrating uncertainty into a full climate-economy integrated assessment model. Recently, a literature following Golosov et al (2014) has developed analytic IAMs that do not require advanced numerical methods. However, assumptions such as logarithmic utility combine to make the model effectively linear, which can make uncertainty uninteresting in these settings.…”

Second-Best Renewable Subsidies to De-carbonize the Economy: Commitment and the Green Paradox

“…We use an annual version of the decadal model of the linear carbon cycle put forward by Golosov et al (2014) and based on Archer (2005) and Archer et al (2009):…”

“…6 About 20% of carbon emissions stay up 'forever' and the remainder has a mean life of about 300 years, so ϕ = 1−(1−0.0228) 1/10 = 0.002304, where 0.0228 is the parameter proposed for the decadal model in Golosov et al (2014). The parameter ϕ 0 = 0.393, is calibrated so that about half the carbon impulse is removed after 30 years.…”

“…However, policy makers have an incentive to renege after some time has lapsed by increasing the renewable subsidy and bringing forward the carbon-free era even more and locking up even more carbon in the crust of the earth. Section 2 discusses a simple two-stock model of carbon accumulation in the atmosphere and global mean temperature due to Golosov et al (2014) and discusses our benchmark specification of climate damages which are bigger at higher temperatures than Nordhaus (2008Nordhaus ( , 2014 following recent suggestions by Stern (2013) and Dietz and Stern (2014). Section 3 formulates the command optimum for our general equilibrium IAM of climate change and Ramsey growth.…”

Limit pricing and the (in)effectiveness of the carbon tax

“…Much research efforts currently revolve around the design of the optimal carbon tax: see the influential works by Chakravorty, Moreaux and Tidball (2008), Metcalf (2008), Sinn (2008), Golosov, Hassler, Krusell and Tsyvinski (2014), van der Ploeg and Withagen (2014), among many others. It is hoped that both the taxation of carbon resources like oil and the support to non-carbon substitutes are effective instruments to curb carbon emissions that are responsible for global warming.…”