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Environmental Taxes and Subsidies

Paper Session

Friday, Jan. 4, 2019 10:15 AM - 12:15 PM

Atlanta Marriott Marquis, M202
Hosted By: Association of Environmental and Resource Economists
  • Chair: Justine Hastings, Brown University

Effects of Severance Tax on Economic Activity: Evidence from the Oil Sector

Jason Brown
Federal Reserve Bank of Kansas City
Peter Maniloff
Colorado School of Mines
Dale Manning
Colorado State University


State and local policymakers must balance taxing economic activity to generate
government revenue with the potential loss of activity with higher taxation. Despite the
important fiscal and economic implications of how drilling activity responds to changes in
severance tax rates, there is little empirical evidence on the sensitivity of drilling activity to state
severance tax rates. Moreover, little is known about the degree of spatial spillovers from tax rates
in neighboring states. The purpose of this paper is to estimate how responsive firms are to
differences in severance tax rates across states and over time. We investigate if firms respond
differentially to oil prices and severance taxes, and whether or not firms respond to neighboring
states’ severance tax rates.
Using data from Drillinginfo, we look at all oil wells drilled between 1980 and 2015 in
reservoirs that cross state lines. By focusing on reservoirs that cross state lines, we use fixed
effects to control for both reservoir (i.e., unobserved geologic quality) and unobserved state
characteristics such as permitting and regulatory ease. We find a stable and inelastic short-run
price elasticity of drilling equal to 0.8. We also find an inelastic response to severance taxes,
with a 1 percent increase in the dollar-per-barrel tax rate associated with a 0.3 percent reduction
in drilling. The positive response to neighboring states’ tax rates is small and does not differ
statistically from zero. It is also statistically smaller than the own-state elasticity.
Our estimates indicate that an increase in revenue from higher severance tax rates more
than offsets the resulting decrease in drilling activity. The policy implication is that small
increases in severance tax rates can allow states to increase revenue. Furthermore, engaging in
tax competition may lead to revenue losses in competing states.

Pollution and Unemployment over the Business Cycle

John Gibson
Georgia State University
Garth A. Heutel
Georgia State University


The effects of environmental policy on unemployment are important, since much political
opposition to environmental policy stems from its perceived effect on jobs. How environmental policy
interacts with the business cycle is important, because cyclical fluctuations can have important real
effects on the demand for environmental quality and on the costs of reducing emissions. While existing
papers have investigated the impact of environmental policy and unemployment over the business
cycle, as well as the unemployment effects of environmental policy in a static context, no current study
examines these three issues – environmental policy, unemployment, and business cycles – together.
We do so by developing a dynamic stochastic general equilibrium (DSGE) model in which fluctuations
are driven by productivity shocks, as in real business cycle (RBC) models. Pollution is modeled as a
byproduct of production that can negatively affect productivity, as in the RBC models of Heutel (2012)
and Fischer and Springborn (2011). Unemployment is introduced into our RBC environment using the
Diamond-Mortensen-Pissarides search and matching process, following Atolia, et al. (forthcoming a,b).
We calibrate our model to reflect key features of the U.S. economy and use it to simulate
unemployment and efficiency effects of several environmental policies. We solve for the optimum
pollution tax rate over the business cycle when unemployment is endogenous. We show the effect that
environmental policy has on cyclical unemployment. We consider the effects of two different policy
instruments – a pollution tax and a pollution quantity restriction – on efficiency and unemployment. We
consider both static policies, where the tax rate or the quantity restriction is fixed over the cycle, and
dynamic policies, where the policy intensity is allowed to vary over the business cycle. Incorporating
unemployment into RBC models of environmental policy can guide policymakers into designing more
efficient and more equitable policies.

A Subsidy Inversely Related to the Product Price

Takahiko Kiso
University of Aberdeen


Many government programs aim to promote the use of energy-saving or green products with
positive externalities by offering financial incentives (e.g., rebates and tax credits) to consumers
and partially offsetting the purchase cost. Typically, subsidy payment per unit quantity
is independent of or proportional to its price (“specific” or “ad valorem”), or determined
by a mixture of these two forms.
A curious case motivating this paper is a Japanese subsidy program on solar PV system
purchase in which rebate payment increased as the product’s (pre-rebate) price went down,
making the demand faced by sellers more elastic and thus leading to lower (pre-rebate) prices,
as transaction data indicate, and further accelerated diffusion of the technology. The literature
has not studied this type of policy design. We propose and analyze a scheme in which subsidy
payment is conditional on the price being less than a government-set threshold, and increases
as the price goes down, in proportion to the distance from the threshold.
We find that under imperfect competition this inversely price-related (IPR) subsidy has two
advantages over the widely-used specific or ad valorem subsidy. First, it can induce a given
market output (the regulator’s target) with less government outlay than the other forms. Second,
while achieving this target, the regulator can also flexibly adjust the policy’s incidence
on producers and consumers.
A simulation based on an actual U.S. subsidy program for electric car buyers shows a remarkable
saving of up to 50–81% in government expenditure if the same market sales were
realized under the IPR subsidy instead of the current specific subsidy of $7,500. Regarding
the incidence on producers, by choosing the IPR scheme’s parameters, the regulator can flexibly
adjust equilibrium producer surplus in the range of $63–169 million lower and $125–150
million higher than under no government intervention.

Market Power in Coal Shipping and Implications for U.S. Climate Policy

Louis Preonas
University of California-Berkeley


Economists have widely endorsed pricing CO2 emissions to internalize climate changerelated
externalities. Doing so would significantly affect coal, which is the most carbonintensive
major energy source. However, U.S. coal markets exhibit an additional distortion,
as the railroads that transport coal to power plants can exert market power.
This upstream distortion can mute the price signal of a corrective tax, due to changes
in markups or incomplete tax pass-through. In this paper, I provide the first empirical
estimates of how coal-by-rail markups respond to changes in coal demand. I find
that rail carriers reduce coal markups when downstream power plant demand changes,
due to a decrease in the price of a natural gas (a competing fuel). I estimate markup
changes that vary substantially across coal plants, resulting from a combination of heterogeneous
transportation market structure and plant-specific demand shocks. Since
low natural gas prices and a CO2 emissions tax similarly disadvantage coal, observed
decreases in coal markups imply that pass-through of a federal carbon tax to coal power
plants may be heterogeneous and incomplete. This could substantially erode the environmental
benefits of a price-based climate policy. My results suggest that decreases
in coal markups have increased recent climate damages by $2.4 billion, compared to a
counterfactual where markups do not change.
Justine Hastings
Brown University
Marc Hafstead
Resources for the Future
Sumeet Gulati
University of British Columbia
Gabriel Lade
Iowa State University
JEL Classifications
  • Q5 - Environmental Economics
  • H2 - Taxation, Subsidies, and Revenue