Corrective Taxes and Auctions of Rights in the Control of Externalities

Abstract

Auctions of pollution rights have sometimes been suggested as an alternative to corrective taxes. These two methods of pollution control are not, in general, equivalent, however. When pollution rights are auctioned, the right to pollute is equivalent to the right to produce, so the auction of rights raises the possibility that the competitiveness of the market could be reduced. Individual producers have an incentive to purchase large amounts of pollution rights in order to gain some degree of monopoly power over the market. This possibility does not exist when corrective taxes are used instead.