Tax/subsidy policies in the presence of environmentally aware consumers

We study policy measures to improve environmental quality in the presence of environmentally aware consumers. We consider two sets of policy instruments—uniform policies for the firms and policies that discriminate between the firms based on their environmental quality. For the latter set, either the better performer is rewarded with a subsidy or, the worse performer is punished with a tax. We find that while a uniform subsidy policy improves average environmental quality, a uniform tax policy worsens it. Further while a discriminatory subsidy policy reduces total pollution and enhances aggregate welfare, a discriminatory tax policy may increase total pollution and may reduce aggregate welfare.