Optimal Taxes on Fossil Fuel in General Equilibrium

Mikhail Golosov, John Hassler, Per Krusell, Aleh Tsyvinski

Research output: Contribution to journalArticle

203 Scopus citations

Abstract

We analyze a dynamic stochastic general-equilibrium (DSGE) model with an externality-through climate change-from using fossil energy. Our central result is a simple formula for the marginal externality damage of emissions (or, equivalently, for the optimal carbon tax). This formula, which holds under quite plausible assumptions, reveals that the damage is proportional to current GDP, with the proportion depending only on three factors: (i) discounting, (ii) the expected damage elasticity (how many percent of the output flow is lost from an extra unit of carbon in the atmosphere), and (iii) the structure of carbon depreciation in the atmosphere. Thus, the stochastic values of future output, consumption, and the atmospheric CO2 concentration, as well as the paths of technology (whether endogenous or exogenous) and population, and so on, all disappear from the formula. We find that the optimal tax should be a bit higher than the median, or most well-known, estimates in the literature. We also formulate a parsimonious yet comprehensive and easily solved model allowing us to compute the optimal and market paths for the use of different sources of energy and the corresponding climate change. We find coal-rather than oil-to be the main threat to economic welfare, largely due to its abundance. We also find that the costs of inaction are particularly sensitive to the assumptions regarding the substitutability of different energy sources and technological progress.

Original languageEnglish (US)
Pages (from-to)41-88
Number of pages48
JournalEconometrica
Volume82
Issue number1
DOIs
StatePublished - Jan 2014

All Science Journal Classification (ASJC) codes

  • Economics and Econometrics

Keywords

  • Climate change
  • Optimal policy
  • Optimal taxes

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