The above analysis applies to any level of an emissions tax. But what is
the level at which an emissions tax should be set to achieve allocative
efficiency? If the regulatory agency is able to obtain a good estimate of the
marginal external cost of the pollution, it could set the tax rate just equal
to that amount. In such a case, polluters would be forced by the tax to
internalize the full pollution externality, and allocative efficiency would be
achieved. In terms of Figure 17-1 , each firm’s private marginal cost
curve would shift up by the full amount of the tax (set to equal the
marginal external cost, MEC) and thus the allocatively efficient level of
output (and pollution) would be produced.
A second advantage of using emissions taxes is that regulators are not
required to specify anything about how polluters should abate pollution
and thus are not required to have expertise about the firms’ technologies.
Rather, polluters themselves can be left to find the most efficient
abatement techniques. The profit motive will lead them to do so because
they will want to avoid paying the tax.
Emissions taxes lead profit-maximizing firms to abate pollution in a cost-minimizing manner.
If the tax is set equal to the marginal external cost of the pollution, the externality will be fully
internalized and the allocatively efficient amount of pollution abatement (and output) will be
produced.A third advantage of an emissions tax is the incentive it creates for
longer-term innovation. With direct regulatory controls, firms are
required to reduce pollution only to the point where the regulation is
satisfied; there is no economic incentive to reduce further. In contrast, an