The choice of environmental policy instruments under correlated uncertainty

This paper analyzes how the presence of correlated uncertainty between the cost and benefit of environmental pollution control can affect the choice o f policy instruments. It is shown that the superiority of the nonlinear-tax instrument in which the corrective tax coincides with the expected schedul e of marginal benefit may break down in favor of a linear-tax or a quantity instrument when the policy environment shifts from the case of independent ly distributed to the case of correlated uncertainties. With various combin ations of parameter values of thr two probability distributions, we also co nstruct three distinct ranges in each of which one instrument turns out to be superior to the other two. (C) 2001 Elsevier Science B.V. All rights res erved.