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A Stackelberg Model on Taxing Polluting Firms

By George Halkos


In this paper we propose a leader – follower dynamic model of taxation with the government imposing a tax to internalize externalities caused by polluting firms. As expected the Stackelberg games with the government acting as leader yield time inconsistent outcomes. We first show how time inconsistency can be avoided adopting specific utility functions. We then propose a pollution model that uses abatement as the value of accumulated pollution stock and find that the outcome of the proposed Stackelberg model is time consistent with an open – loop informational structure. This yields a tax factor that is time independent. Finally, we show that the result of the game is inefficient compared to the social planner dynamic game.

Topics: C61 - Optimization Techniques; Programming Models; Dynamic Analysis, D43 - Oligopoly and Other Forms of Market Imperfection, C62 - Existence and Stability Conditions of Equilibrium, H32 - Firm
Year: 2008
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