Cameron Hepburn

Time-inconsistent environmental policy and optimal delegation

with Helm and Mash, Royal Economic Society, Conference Paper, 2004

Time consistency problems can arise when environmental taxes are employed
to encourage firms to take irreversible abatement decisions. Setting a high carbon tax, for instance, would induce firms to invest in low-carbon technology,yet once investment has occurred the government can then reduce the carbon tax to better achieve other objectives: lower energy prices, redistribution, and electoral success. The resulting time inconsistency discourages firms from investing in the first place. We propose an institutional solution to this problem, adapted from the monetary policy literature: the commitment outcome can be achieved through delegation to an ‘environmental policymaker’, akin to a conservative central banker.