Optimal Taxes on Fossil Fuel in General Equilibrium
Golosov, M., Hassler, J., Krusell, P. and Tsyvinski, A.
Summary:We embed a simple linear model of the carbon cycle in a standard neoclassical growth model where one input to the production function, oil, is non-renewable. The use of oil generates carbon emission, the key input in the carbon cycle. Changes in the amount of carbon in the atmosphere drive the greenhouse effect and thereby the climate. Climate change is modeled as a global damage to production and is a pure externality. We solve the model for both the decentralized equilibrium with taxes on oil and for the optimal allocation. The model is then used to find optimal tax and subsidy polices. A robust model finding is that constant taxes on oil have no e¤ect on the allocation: only time-varying taxes do. A key finding is that optimal ad valorem taxes on oil consumption should fall over time. In the simplied version of the model, optimal taxes per unit of oil should be indexed to GDP. A calibrated, less simplified model also generates declining, and initially rather substantial, taxes on oil.
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