Optimal Regulation for Production with Multiple Externalities

Optimal Regulation for Production with Multiple Externalities

Since many individual production activities release more than one pollutants, policy outcomes of one regulation often complement or contradict those of another regulation. Considering this, anintegrated approach to dealing with multiple negative externalities was developed. In practice, however, regulating pollutants separately at a time rather than anintegrated approach is a common regulatory model and, as a result, the inefficiency of regulation arises. The inefficiency even increases as individual environmental policy is implemented with uncoordinated agenda. This paper employs a game theoretic model and explores the issue of optimal regulation for multiple production externalities. In the model, corrective tax rates for two externalities represent the level of regulation. According to findings of our analytical model, regulation level under a comprehensive approach, which simultaneously determines tax rates in year 1, is consistent with Pigouvian rate. Meanwhile, regulation level under a separate approach, which introduce two regulations sequentially, one in the first year and the other in the second year, deviates from the optimal level: the earlier regulation in the first year is higher and the latter one in the second year is lower than that of a comprehensive one. To avoid distortions associated with the sub-optimal level of regulation, our model discourages a use of excessive forward-looking when the level of regulation is made sequentially.