Dynamic Relative Standards versus Emission Taxes in a Putty-Clay Model

The paper derives the dynamics of pollution taxes and relative standards-which set bounds on emissions per unit of output-and the resulting optimal replacement of capital goods in a vintage model under the putty-clay assumption. Comparing policies that are constrained by the same aggregate pollution target level, the productive life of capital is longer under dynamic relative standards, as the variable cost of pollution imposed on aging capital is lower. As a result, the absolute level of output from the industry is generally higher under dynamic relative standards than under taxes. The results also show, under reasonable assumptions, that the pollution goal will be achieved using cleaner technologies under dynamic relative standards. These results can explain, from a political economy perspective, the prevalence of dynamic relative standards in regulations.