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K EENA L I
Brigham Young University
December 19, 2014
Abstract
With a general definition of pollution, modelled after carbon emissions,
what are the policy implications of a tax on pollution? This paper looks at answering that question by presenting and solving a dynamic stochastic general
equilibrium model that includes an externality from pollution in addition to
shocks on production. The model is estimated and calibrated according to
the US economy and carbon dioxide emissions, a topic of increasing interest
in public policy.
Introduction
The problem of pollution, although not novel, has been increasingly scrutinized
in public forums across differing fields. It seems that everyone in every degree
has an opinion and an argument for their views on both the legitimacy of the
problem itself, and viability of sollutions. In this paper, I will explore the latter
while taking the former as given.
A DSGE model is an appropriate approach to tackle the problem of pollution.
A handful of papers looking at specific topics in environmental change using
DSGE models exist (Cai, Judd et al, Heutrel, Golosev et al). After looking at these
papers, it is clear that approaches vary, specifically with regards to the punishment
function. How do we model the negative impact of pollution? Is it disutility
or decreased production? There are arguments for and against both sides, and
approaches that reflect the disparate opinions. For my model, I will choose to
simply include this punishment idea in a tax on consumption (Cai). I assume that
the decrease in consumption includes the disutility of pollution. The two main
fields addressing climate change are split between a tax and a cap (Dissou et al).
Although I would be interested in exploring a cap and trade approach in a future
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model, the choice of tax seems like a simpler policy approach and provides room
to include the punishment idea developed by earlier authors.
Finally, I look at general pollution instead of a specific type of emission because
this will give me more freedom to change my parameters in a way that could mock
different types of pollution. To make my model more realistic, I calibrate it to
values congruent to carbon emissions, using the same units of atmospheric carbon
(GtC), however, under the inevitably false assumption that different types of
pollution have the same relative emissions-to-stock ratio as carbon, I will change
my parameters to simulate the differing types.
Model
We begin with a simple RBC model. The economy is populated by many atomistic
households that own capital stock k t in any given time period t. Agents seek to
maximize utility that takes the functional form of:
u(c) =
1
( c 1 1 )
1
u0 (c ) = c
(1)
(2)
(3)
(4)
The households make wages wt that are paid for by firms and consume ct and
rt is the interest rate.
c t = w t + (1 + r t ) k t 1 k t
(5)
These households are productive according to a productivity zt that is uncertain due to a stochastic shock ez .
z t = z z t 1 + e z
(6)
(7)
Mt = T Yt ey
y t = y y t 1 + e y
(8)
(9)
(10)
We assume that pollution was no direct effect on output Yt , nor does it have
an effect on utility.
At the beginning of each period t, zt is known. All factor markets are open and
clear, so k t is loaned out to firms and rt is determined while l is hired and wt is
determined. The production of goods occurs. k t+1 is chosen and consumption ct
occurs. A temporary shock zt+1 is revealed and the period ends.
So given the information of prices and shocks = {w, r, z, y}, the household
solves the following problem when factor markets clear:
V (k t , ) = max u(ct ) + E{V (k t+1 , t+1 )}
kt
(11)
c t 1
(12)
(13)
(14)
= E{c
t+1 (1 + rt+1 )}
ct
) (1 + rt+1 )}
1 = E{(
c t +1
ct
(15)
(16)
Calibration
Calibration of the parameters comes from two main groups of 1) traditional
macroeconomic parameters taken from previous RBC literature and emissions
related parameters taken from economics and chemistry to estimate the cost and
benefits of emission reductions. This model is calibrated using the carbon dioxide
emissions in the US economy.
In the production function, the parameter 0 < < 1 accomodates positive
diminishing marginal returns. The USs capital share of national income is .36, so
this is value of used. Similarly, capital depreciation is found to be .025 and the
discount factor = .98627 is consistent with quarterly rate of return to capital of
1 percent, or equivalently an annual discount rate of 5 percent and annual capital
depreciation rate of 9.6 percent. From an analysis of Census Bureau data using a
Hodrick-Prescott filter to detrend time series data of GDP and monthly emissions
( = 1600), we find the standard deviation of cyclical GDP to be 1.31 percent
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Analysis
Taking our other parameters as given, I assume that the current state of the U.S.
economy will hold as I conduct my analysis based on changing the emissions tax
rate, T. I begin with a tax that is an estimated 10 percent of wage and 20 pecent of
emissions. My steady state results are:
z
c
w
r
k
Y
y
M
x
0
2.48679
2.23677
0.0389211
32.3264
3.49495
0
3.72735
1774.93
At the steady state, both our production shock z and our pollution shock y are
at 0. With T = .2, consumption c is 11 percent greater than wage w. Emissions M
are at 3.72735 GtC, and total pollution stock is 1774.93 GtC. It isnt clear that a 10
percent tax on wages has a large impact on the amount of emissions.
Looking at the impulse response graphs will give us insight into how differing
shocks to production z and pollution y affect our other variables.
From this figure we see that as the shock to pollution y decreases, so does
emissions M in a period. The total stock of pollution x, is increasing still, as
emissions are positively correlated with GDP Y. However stock of pollution is
increasing at a decreasing rate, as we can see by the tapering off of x. This is pretty
straightforward and intuitive.
From this figure we see that as production shocks z decrease, so does consumption c, wage w and GDP Y. This makes sense as the shock to production
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0
0.486788
2.23677
0.0389211
32.3265
3.49495
0
3.38644
1612.59
These results arent too satisfying. Even if we increased taxes from .2 to 2.2,
over 98 percent of wages, it is clear that our effect on abatment is almost trivial.
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0
1.48679
2.23677
0.0389211
32.3264
3.49495
0
2.91246
1386.88
Our results are more promising, with emissions decreasing around 13 percent,
and the total stock of emissions decreasing over 20 percent. When we set =
2, T = 1.2, our results are even more optimistic:
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z
c
w
r
k
Y
y
M
x
0
1.48679
2.23677
0.0389211
32.3264
3.49495
0
2.42705
1155.74
With this doubling of effectiveness, we see that each periods emissions decrease, with a significant drop in the stock of pollution to 1155.74 GtC - nearly a 40
percent drop from our original callibration. This is an illuminating result. Throwing money at pollution does not solve the problem unless abatement methods are
effective.
Taking a different approach with the model, I look at the pollution shock
yt = y yt1 + ey . With my original y shock to pollution set high at .95, I now
look to assume that each years pollution shock has no correlation with the
previous years. Although this makes less intuitive sense with carbon dioxide
emissions due to a greenhouse effect that perpetuates and exacerbates the current
problem, with other types of pollution, perhaps this is not unrealistic. For example,
random shocks due to natural disasters could be argued as more random and less
autocorrelated to previous years shocks.
0
0.486788
2.23677
0.0389211
32.3265
3.49495
0
1.58861
756.483
Conclusion
Although our model is a very simplistic representation of the actual world, it
presents a few interesting concepts that are not entirely illogical or unintuitive.
Our initial callibration suggests:
1. we are grossly underestimating the amount of taxes we need to truly decrease pollution.
2. Simply throwing money at the problem does not solve it - we need to be
effective/efficient with our funds.
Upon further examination it seems that emissions and the stock of pollution
are greatly affected by more than just taxes and efficiency. M and x are affected
by:
1. Shocks to production z, and
2. Shocks to pollution y.
Although one way to solve the problem of pollution is to emply a duel front
of increasing taxes and increasing efficiency, it seems that there is an underlying
underestimation of the problem of pollution and its sensitivity to outside factors.
Our analysis suggests that the best way to address the problem of pollution is to
begin better understanding the problem itself. Perhaps initially obvious policy
changes will not be as effective in long term abatement.
To further explain the problem of pollution and abatement, I would be interested in adding a disutility variable that decreases individual utility as emissions
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References
Cai, Judd, Lontzek. "DSICE - Dynamic Stochastic General Equilibrium Analysis
of Climate Change Policies and Discounting."
Heutel, Garth. "How Should Environmental Policy Respond to Business
Cycles? Optimal Policy under Persistent Productivity Shocks." Harvard Kennedy
School Southern Economics Association (2008). Print.
Golosov et al, "OPTIMAL TAXES ON FOSSIL FUEL IN GENERAL EQUILIB S88. Print.
RIUM." Econometrica Vol. 82.No. 1 (2014): 41A
Dissou et al, "Cap or Tax emissions? A Multi-sector DSGE Analysis."
US. Census Bureau
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