Using Automatic Tax Changes to Control Pollution Emissions

In the absence of information about abatement costs, the level of emissions tax needed to achieve a target level of pollution abatement is unknown. This problem can be overcome by using an iterative procedure in which the tax is adjusted when current emissions exceed or fall short of the target. This idea has become part of the standard textbook material, but there has been no formal analysis of its dynamic properties. We find that emissions can be reduced to the target whether firms behave strategically or not, but the strategic element changes the welfare properties of the mechanism.