When can carbon abatement policies increase welfare? The fundamental role of distorted factor markets

This paper employs analytical and numerical models to assess the welfare ef fects of a revenue-neutral carbon tax and (nonauctioned) carbon emissions p ermits, taking into account preexisting tax distortions in factor markets. The presence of preexisting taxes significantly raises the general equilibr ium costs of both policies. This cost increase is much greater under emissi ons permits, since this policy does not generate revenues to reduce distort ionary taxes. Under our central estimates emissions permits cannot increase welfare unless environmental damages exceed about $18 per ton of carbon. I n contrast, an appropriately scaled carbon tax is welfare-improving so long as environmental damages are positive. (C) 1999 Academic Press.