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Targeting Green Payments under a Budget Constraint

Conventional wisdom holds that optimal abatement subsidy rates should be differentiated across firms according to the (actual or imputed) marginal damages created by a firm’s emissions. When subsidy rates are developed under a limited budget, we find they may be optimally differentiated to target, in addition to marginal damages, features such as abatement costs, income transfer, and producer participation. The degree to which subsidy rates optimally target these other features depends on how the subsidy is implemented, or more specifically, on how benchmarks for pollution abatement are defined. The results provide insight into current policy debates. (JEL Q24, Q38)