14th journées Louis-André Gérard-Varet

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Robust Optimal Taxation and Environmental Externalities
ted temzelides, Xin Li, Borghan Narajabad

Last modified: 2015-05-06

Abstract


We study optimal taxation in a dynamic stochastic general equilibrium model where agentsare concerned about model uncertainty regarding climate change. An externality from green-house gas emissions adversely a¤ects the economy.s capital stock. We assume that themapping from climate change to damages is subject to uncertainty, and we adapt and usetechniques from robust control theory in order to study e¢ ciency and optimal policy. Weobtain a sharp analytical solution for the implied environmental externality and we charac-terize dynamic optimal taxation. A small increase in the concern about model uncertaintycan cause a signi.cant drop in optimal energy extraction. The optimal tax which restoresthe social optimal allocation is Pigouvian. Under more general assumptions, we develop arecursive method and solve the model computationally. We .nd that the introduction ofuncertainty matters qualitatively and quantitatively. We study optimal GDP growth in thepresence and in the absence of concerns about uncertainty and .nd that these can lead todi¤erent conclusions.