Pollution Taxes When Firms Choose Technologies

Abstract

We consider the properties of a pollution tax when the regulated firm has a discrete choice of technologies with which to reduce pollution. The firm's technology choice makes possible two sequences of play: the traditional one in which the regulator moves first, committing to a tax rate before the firm adopts a technology, and an alternative one in which the firm moves first by adopting a technology. We find that a range of pollution levels, including possibly the first-best one, are unattainable when the regulator moves first. The regulator may be better able to achieve the first-best outcome when the firm moves first.