Illegal Emissions and the Social Cost of Environmental Policy

Abstract

This paper investigates seminal works on illegal emissions and the social costs of environmental policy that seeks to achieve a given aggregate emissions target. First, we re-examine the Sandmo (2002) model of incomplete compliance and demonstrate that the cost effectiveness of the ‘economic instrument’, which minimizes the aggregate abatement cost while achieving the targets, is not robust against noncompliance by the regulated firms. Next, we refine the propositions of Macho-Stadler and Pérez-Castrillo (2006) who study monitoring and enforcement of environmental taxation and argue that all firms evade the environmental taxes when an optimal audit program is implemented. Finally, we review Strunland (2007) who defines the social costs of emissions trading in the broadest sense and maintains that full compliance by all firms is desirable, and reconsider his proposition that the cost of a linear penalty schedule is lower than that of a strictly convex one.