Optimal environmental taxes and standards: Implications of the materials balance

This paper investigates the implications of the materials balance for optimal environmental policy. We find that neglecting the materials–emissions relationship – as is common in models of optimal environmental regulation – implies biases, whose sign depends on the regulatory instrument chosen. When emissions are regulated through an emission tax, the seemingly optimal tax is too high. When regulation proceeds through the use of an emission standard, the seemingly optimal standard is too lax.