The Choice between Emission Taxes and Output Taxes under Imperfect Monitoring

We consider a regulatorʹs choice between environmentally motivated emissions taxes and output taxes. We investigate how the optimal instrument depends on the monitoring cost function, the firmʹs technology, and on social preferences regarding output and environmental quality. Pure emissions taxes are usually not optimal with monitoring costs. Pure output taxes are optimal under sufficiently high monitoring costs, sufficiently limited options for emission reduction by means other than output reduction, and sufficiently high substitutability of the output. Finally, conditions for the optimality of mixed taxes are given.