Optimal Climate Change Policies When Governments Cannot Commit

Alistair Ulph () and David Ulph ()
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Alistair Ulph: University of Manchester
David Ulph: University of St Andrews, Oxford University Centre for Business Taxation

No 921, Working Papers from Oxford University Centre for Business Taxation

Abstract: This paper examines the optimal design of climate change policies in the context where governments want to encourage the private sector to undertake significant immediate investment in developing cleaner technologies, but the carbon taxes and other environmental policies that could in principle stimulate such investment will be imposed over a very long future. The conventional claim by environmental economists is that environmental policies alone are sufficient to induce firms to undertake optimal investment. However this argument requires governments to be able to commit to these future taxes, and it is far from clear that governments have this degree of commitment. We assume instead that governments cannot commit, and so both they and the private sector have to contemplate the possibility of there being governments in power in the future that give different (relative) weights to the environment. We show that this lack of commitment has a significant asymmetric effect. Compared to the situation where governments can commit it increases the incentive of the current government to have the investment undertaken, but reduces the incentive of the private sector to invest. Consequently governments may need to use additional policy instruments – such as R&D subsidies – to stimulate the required investment.

Date: 2009
New Economics Papers: this item is included in nep-ene and nep-env
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