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Robust Dynamic Optimal Taxation and Environmental Externalities

Xin Li, Borghan Nezami Narajabad and Theodosios Temzelides

No 2014-75, Finance and Economics Discussion Series from Board of Governors of the Federal Reserve System (U.S.)

Abstract: We study a dynamic stochastic general equilibrium model in which agents are concerned about model uncertainty regarding climate change. An externality from greenhouse gas emissions damages the economy's capital stock. We assume that the mapping from climate change to damages is subject to uncertainty, and we use robust control theory techniques to study efficiency and optimal policy. We obtain a sharp analytical solution for the implied environmental externality and characterize dynamic optimal taxation. A small increase in the concern about model uncertainty can cause a significant drop in optimal fossil fuel use. The optimal tax that restores the socially optimal allocation is Pigouvian. Under more general assumptions, we develop a recursive method and solve the model computationally. We find that the introduction of uncertainty matters qualitatively and quantitatively. We study optimal output growth in the presence and in the absence of concerns about uncertainty and find that these concerns can lead to substantially different conclusions.

Keywords: uncertainty; robust; Climate change; optimal dynamic taxation (search for similar items in EconPapers)
Pages: 38 pages
Date: 2014-05-29, Revised 2014-05-29
New Economics Papers: this item is included in nep-cmp, nep-dge, nep-ene, nep-env and nep-res
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Working Paper: Robust Dynamic Optimal Taxation and Environmental Externalities (2014) Downloads
Working Paper: Robust Dynamic Optimal Taxation and Environmental Externalities (2014) Downloads
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