Optimal coverage of an emission tax in the presence of monitoring, reporting, and verification costs with an application to greenhouse gas emissions from European agriculture

Résumé

Environmental policies often include exemptions for some firms, e.g. the small emitters. This paper explores the implications of such exemptions in the case of an emission tax, and in the presence of monitoring, reporting, and verification (MRV) costs. We develop an analytical framework capturing the trade-off between the cost-effectiveness of a broader tax base, and the savings on MRV costs enabled by a partial coverage. We characterize the second-best optimal coverage, whereby firms below a threshold value of some observable characteristic are exempted. Since determining this threshold is demanding in terms of information regarding firm-level MRV and abatement costs, we show how limited knowledge about these costs at the aggregate level can be used in practice to approximate the optimal threshold. We apply this framework to assess the welfare implications of such an instrument in the case of greenhouse gas emissions from European agriculture. The findings indicate that exempting the smaller emitters may provide significant savings on MRV costs compared to full coverage, while still incentivizing cost-effective reductions in emissions. Coécrit avec Loïc Henry et Pierre-Alain Jayet