More is less : the tax effects of ignoring flow externalities

Abstract

Using a model of nonlinear decay of the stock pollutant, and starting from the same initial conditions, the paper shows that a tax that only corrects for stock externalities can, at the steady state, be higher than a tax that corrects for both stock and flow externalities. The results indicate that the possibility exists that the optimal corrective tax (correcting for both externalities) may result in a steady state with fewer emissions and lower tax payments than a tax that only corrects for stock externality. Thus, a failure to consider flow externalities may have important implications fior the time path and steady states of production, emissions and taxes, and not just in terms of transitory consumption.