Capital mobility and environmental policy: taxes versus TEP

Emission taxes and tradable-emission-permit (TEP) programs are two popular instruments used to regulate transboundary pollution. In a framework with capital, monopolistic competition, and interregional trade, we show that when capital is immobile, the two instruments are equivalent. When capital is mobile, the TEP program is more efficient. We also find that the presence of capital mobility reverses some conventional results. It may lead the non-revenue-raising instruments to be more efficient than the revenue-raising instruments, which counters the double-dividend hypothesis. With mobile capital, the initial allocation of permits affects the efficiency, which contrasts with the Coase theorem.