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Copyrigh by Inkee Hong 2007 The Disseraion Commiee for Inkee Hong cerifies ha his is he approved version of he following disseraion: Three Essays on Taxaion, Environmen, and Welfare Commiee: Don Fulleron,
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Copyrigh by Inkee Hong 2007 The Disseraion Commiee for Inkee Hong cerifies ha his is he approved version of he following disseraion: Three Essays on Taxaion, Environmen, and Welfare Commiee: Don Fulleron, Supervisor Kenneh Hendricks David J. Eaon Peer J. Wilcoxen Roberon C. Williams Three Essays on Taxaion, Environmen, and Welfare by Inkee Hong, B.A., M.A. Disseraion Presened o he Faculy of he Graduae School of he Universiy of Texas a Ausin in Parial Fulfillmen of he Requiremens for he Degree of Docor of Philosophy The Universiy of Texas a Ausin December 2007 Dedicaion To my family Acknowledgemens I would like o express my hanks o he people who helped me complee his disseraion successfully. My firs hanks go o my supervisor, Professor Don Fulleron who helped me go hrough many phases of my uneven years a he Universiy wih exraordinary undersanding and paience. He showed me how o sudy, research, wrie academic papers. He also showed me how o hink like an economis. I is his encouragemen ha enabled me o carry on whenever I feel los boh in economics and life. I also hank o all my commiee members, Professors Kenneh Hendricks, David J. Eaon, Peer J. Wilcoxen, and Roberon C. Williams for many insighful commens on my disseraion. While working on his disseraion, I shared many disappoinmens and joys wih my friends and colleagues. Dr Soon-ong Choi and Professor Pilky Hong consanly gave me invaluable advices and suppor. Myung-Ho Paik and Joon-Hyung Lee showed me grea hospialiy a he las sage of my disseraion work and Hyun- Kyung Kim and Sang-Hyun Hwang also gave me heir hear-fel suppor. My parens, Seong-Bok Hong and Soon-Tahn Lee, have awaied his disseraion for a long ime, and hey deserve full credi for i. They gave me unlimied suppor whenever I fel depleed financially and emoionally. I am also graeful o my v parens-in-law, i-tae Park and oung-hee Kim. They suppored my family and encouraged me even in he siuaions ohers migh lose paience. I also hank my broher, Jeong-Ki Hong, and siser, In-Jeong Hong. They ook care of everyhing ha I should have done for family while I was away from home for a long period. I will remember heir love and help for he res of my life. And finally, I express my deepes graiude o my wife, Kyung-Lee Park. This disseraion would have remained unfinished wihou her rus and would be nohing wihou her love. vi Three Essays on Taxaion, Environmen, and Welfare Publicaion No. Inkee Hong, Ph.D. The Universiy of Texas a Ausin, 2007 Supervisor: Don Fulleron My disseraion examines heoreically he effecs of environmenal axaion on welfare in various cases. Using a general equilibrium model, he firs chaper shows ha a Pigouvian ax provides a larger welfare gain han an oupu ax, since i induces subsiuion among inpus as well as reducion in oupu of he diry good, while an oupu ax induces only he oupu reducion. Using daa for China and he U.S., numerical simulaion resuls show ha he poenial welfare loss from no being able o use a Pigouvian ax is much larger in developing counries han in developed counries. The second chaper focuses on he fac ha recycled maerial needs reprocessing o be subsiuable for virgin maerial. Reprocessing uses resources and, in he process, generaes polluion. Incorporaing hese imperfec characerisics ino a simple general equilibrium model, I examine how hese realisic facors affec he srucure of axsubsidy schemes when he Pigouvian axes are no available. A generalized Deposi- Refund sysem can achieve he opimum if illegal dumping is no axable. Wihou a Pigouvian ax on illegal dumping, recycling is subsidized for is role in divering illegal vii disposal ino proper disposal. If Pigouvian axes on neiher illegal disposal nor wase from imperfec reprocessing are available, a combinaion of oupu ax on reprocessed maerial and subsidies for clean inpus can be used o resore he opimum. In he process, anoher reason o subsidize recycling emerges: recycling is a clean inpu for imperfec reprocessing. The hird chaper focuses on he validiy of he resuls obained in he firs chaper in he case of wo verically-separaed oligopolies where he upsream indusry is polluing. Using an analyical parial equilibrium model, I show ha a ax on polluion is poenially superior o a ax on inermediae good, since he former can uilize boh he upsream firms inpu subsiuabiliy and he downsream firms inpu subsiuabiliy, while a ax on inermediae good only uilizes he downsream firms inpu subsiuabiliy. I also derive he condiions ha governmen can improve social welfare hrough various revenue-neural ax reforms. viii Table of Conens Lis of Tables...xi Chaper 1 Welfare Effecs of he Environmenal Taxes in Developing Counries Inroducion Pas Experiences wih Economic Insrumens Lieraure Review The Model Tax Reform and Opimal Tax Raes Tax Reform Opimal Tax Raes Numerical Simulaion Assumpions on Parameers The Simulaion Resuls Sensiiviy Analysis Conclusion...48 Chaper 2 Two Reasons o Subsidize Household Recycling: The Effecs of Imperfec Recycling and Reprocessing on he Opimal Recycling Subsidy Inroducion The Model Oucome in he social planner s problem Oucome in he decenralized model Opimal Policies for he Firs-bes Oucomes When he firs-bes Pigouvian axes are available When illegal disposal canno be axed When no Pigouvian axes are available Conclusion and Furher Discussion...72 ix Chaper 3 Welfare Effecs of he Tax Reforms in Two Verically-Separaed Oligopolies wih Environmenal Exernaliy Inroducion The Model Downsream Indusry Upsream Indusry Welfare Changes from Tax Reforms Welfare Improving Tax Policies wih a Lump Sum Transfer o Consumer Welfare Improving Tax Policies wih a Lump Sum Transfer o Consumer A Tax on Polluion wih a Lump Sum Transfer o Consumer Tax Policies wih No Lump Sum Transfer Ad Valorem Taxes on Boh Goods Emissions Tax Conclusion Appendices Appendix A Appendix of Chaper A.1 Derivaion of (1.19) A.2 How o Solve he Sysem of Equaions A.3 The Lis of Polluing Indusries Appendix B Appendix of Chaper B.1 Derivaion of Equaion (3.12) B.2 Derivaion of Equaion (3.26) B.3 Derivaion of Equaion (3.31) Bibliography Via.132 x Lis of Tables TABLE 1.1: ASSUMPTIONS ON PARAMETER VALUES 33 TABLE 1.2: SIMULATION RESULTS (IN PERCENT) 35 TABLE 1.3: THE DECOMPOSITION OF THE SIMULATION RESULT B PARAMETER ASSUMPTION (IN PERCENT) 39 TABLE 1.4: SENSITIVIT ANALSES (IN PERCENT) 42 FIGURE 1.1: SENSITIVIT ANALSIS FOR SUBSTITUTION ELASTICI BETWEEN OUTPUTS 45 FIGURE 1.2: SENSITIVIT ANALSIS FOR SUBSTITUTION ELASTICI BETWEEN INPUTS 46 FIGURE 1.3: SENSITIVIT ANALSIS FOR LABOR SUPPL ELASTICI 47 xi Chaper 1 Welfare Effecs of he Environmenal Taxes in Developing Counries 1.1 INTRODUCTION Many developed counries have implemened various policy measures o proec and improve he qualiy of heir environmen. Recen sudies (OECD, 1995; 1996) have idenified major advanages o a greaer use of economic insrumens (EIs) such as axes or charges and radable permis in environmenal policy, compared o command and conrol (CAC) approaches. However, EIs are heerogeneous policy ools. The exbook case of a Pigouvian ax is far from widely used, mainly due o he informaion requiremens and oher insiuional consrains (McMorran and Nellor, 1994). The successful implemenaion of EIs migh heavily depend on pre-exising insiuional condiions (see, for example, Russell and Powell, 1996; Smih, 1997). These insiuional condiions are paricularly unfavorable in developing counries. Exising regulaions, usually fashioned afer hose in developed counries, have ofen proven unenforceable and impracical. The effors required o cope wih he design of hese policies and insiuional changes for launching EIs are addiional burdens on hose developing naions (Panayoou, 1991; Serôa da Moa, e al 1999). Developing counries also have oher srucural characerisics differen from hose of developed counries. They ofen use more polluing fuels such as coal and unleaded gasoline, engage in more-harmful and less-efficien consumpion and producion aciviies such as slash-and-burn farming in Brazil, and drive more polluing vehicles 1 per mile raveled such as small scooers in many Souh Asian counries. Finally, hey end o have agriculural ha are large and ofen under-axed, polluing indusries ha accoun for a large proporion of oal oupu, and high marginal environmenal damages per uni of oupu. This chaper examines how hese consrains affec he welfare gain from he inroducion of environmenal axes in developing counries. I uses a simple analyical general equilibrium model wih hree secors: one axable clean manufacuring secor, one polluing manufacuring secor, and one non-axable clean secor ha represens subsisence farming and/or small non-marke producion aciviies. Firs, his chaper heoreically shows ha an ideal Pigouvian ax provides larger welfare gain han an oupu ax. Leaving aside problems of monioring or enforcemen, a Pigouvian ax is an ideal insrumen o inernalize an environmenal exernaliy because i reduces consumpion of he oupu as well as use of he diry inpu. Since emissions hemselves are ofen hard o measure, however, boh developed and developing counries have ofen relied on he axaion of oupu of he polluing indusry. Using he log-linearizaion echnique, his chaper solves for he second-bes opimal Pigouvian ax and oupu ax in he presence of a disorionary ax on marke use of labor (or equivalenly, a pre-exising consumpion ax on all marke goods). Second, he model allows srucural consrains o be incorporaed and quanified hrough a se of parameer values raher han relies on anecdoal evidence ha developing counries have experienced. The chaper uses daa for China, which is believed o share many characerisics commonly observed in developing counries in a broad sense. Using he daa for China, I calculae he ne welfare effecs of eiher using he ideal Pigouvian ax insead using an oupu ax. The numerical simulaion resuls 2 show ha he ne welfare gain from he use of a Pigouvian ax could be more han four imes larger han ha of an oupu ax. On he oher hand, he welfare gain from using a Pigouvian ax is only 50 percen larger han ha of an oupu ax in developed counries. Therefore, he poenial welfare disadvanage from using oupu axes for environmenal purposes appears o be greaer in developing counries. This poenial welfare disadvanage implies ha developing counries effors in various srucural reforms have imporan effecs on he welfare oucomes of heir environmenal policies. Moreover, he welfare disadvanage does no imply ha developing counries should avoid using environmenal oupu ax insrumens. Alhough an inroducion of an environmenal oupu ax offers smaller welfare gain in developing counries han in developed counries, he welfare gain from oupu ax insrumens migh be subsanial, considering he poenial savings from monioring and enforcemen aciviies. Secion 1.2 briefly overviews pas experiences wih EIs, while Secion 1.3 reviews he previous lieraure. In Secion 1.4, I presen he model and derive he opimal ax raes and ne welfare expressions for boh he emissions ax and oupu ax. Secion 1.5 discusses he implicaions of hese analyical resuls, while Secion 1.6 presens simulaion resuls. Secion 1.7 concludes. 1.2 PAST EPERIENCES WITH ECONOMIC INSTRUMENTS The radiional and mos direc approach o environmenal managemen is o impose echnology resricions and guidelines, enforced using fines and fees. Bu his CAC mehod can be difficul and expensive o implemen, monior, and enforce. In he economic lieraure, he CAC approach has been deplored on grounds of boh saic and dynamic inefficiency, because i asks for he same level of compliance by all polluers 3 despie differences in marginal abaemen coss. Furhermore, i does no provide any incenives o polluers for echnical improvemen o reduce polluion in he fuure (Baumol and Oaes, 1988; Cropper and Oaes, 1992). EIs include boh axes and permi sysems, bu he model in his chaper is based on perfec cerainy and hus does no really disinguish beween hem. Since axes and permis are equivalen, I refer only o Pigouvian axes (fees or charges) and environmenal oupu axes. 1 A Pigouvian ax (or emissions ax) is a specific ax per uni of emissions. The opimal rae of ax is equal o he polluan s social marginal environmenal damage (MED) a he socially-efficien level of emissions (Pigou, 1932). In heory, Pigouvian axes reduce polluion in he leas-cos manner: hey encourage polluers o deermine he combinaion of lower oupu, subsiuion among inpus, and invesmen in new echnology ha reduces emissions a leas cos. On he oher hand, axes on oupu or purchased inpus migh be used for environmenal purposes, hough hey have radiionally been used mainly for revenue purposes. 2 In many cases, hey are inended o encourage polluion abaemen by axing oupus or inpus whose use is linked o environmenal damage, raher han axing emissions direcly. Unlike a Pigouvian ax, however, an oupu (or inpu) ax achieves a socially-efficien level of emissions in he leas-cos manner only if he naure of he linkage beween he ax base and he environmenal damage is fixed. Wihou fixed linkage o polluion, hey usually deliver only he oupu effec (Fulleron, e al, 2001). In oher words, hey do no provide incenives o abae emissions per uni of oupu; 1 Some sudies (OECD, 1999b; Smih, 1997) divide environmenal ax insrumens ino charges (or fees) and axes based on wheher hey are requied or no. However, in his paper, I will use all hese erms inerchangeably. 2 I will use Pigouvian ax for a ax per uni of emissions and oupu ax for a ax on oupu of he polluing indusry. Therefore, by my definiion, he mos imporan characerisic in deermining if any paricular ax (or charge) belongs o he Pigouvian ax caegory depends on wheher i direcly his he emissions hemselves. If no, I will call i an oupu ax. 4 hey only reduce consumpion of goods and services produced using emissions. 3 Furhermore, hey may affec oher non-argeed aciviies (Eskeland and Jimenez, 1992). Why are environmenal oupu (or inpu) axes so popular hen? Firs of all, environmenal oupu axes are relaively easier o adminiser han ideal Pigouvian axes. For design and implemenaion of a perfec Pigouvian ax, he environmenal auhoriies would have o monior he sources of polluans coninuously, enforce he poenial polluers o comply, and decide he opimal rae of ax for each polluer. These adminisraive aciviies are by no means easy asks, even in developed counries. 4 The siuaions in many developing counries are worse: heir insiuional weaknesses such as under-funding and inexperience end even furher o limi he effecive implemenaion of Pigouvian axes. 5 Furhermore, i is ofen difficul o inroduce new environmenal axes. In comparison, oupu axes are relaively easy o implemen. 6 Many exising axes are levied on he value of goods and services sold (or he value of incomes paid or received). For example, excise axes on fuel and oher energy producs are probably he mos widespread environmenal axes mainly because of heir adminisraive convenience (OECD, 1999a). 3 For insance, a ax on coal inended o reduce sulfur emissions will also affec manufacurers ha use coal o exrac chemicals for dyeing. If a ax were imposed on he sulfur conen of coal, he manufacurers in he dyeing indusry would unnecessarily be induced o swich o lower-sulfur coal or o find oher sources of chemicals (Blackman and Harringon, 2000). 4 Poliical consideraions or he pracical problems of design and implemenaion such as who is o be axed are ofen he mos imporan facors ha deermine he ypes of policy ools employed (Barhold, 1994). 5 This does no necessarily imply ha environmenal oupu axes are free from such insiuional consrains, only ha such consrains may be smaller for an oupu ax. 6 Smih (1996) poins ou ha where he assessmen, collecion, or enforcemen of he ax can be piggy-backed on o corresponding operaions already esablished for exising axes, he coss of an environmenal ax measure may be significanly lower han where enirely-new adminisraive apparaus and procedures are required. 5 A comprehensive survey of he use of EIs (OECD, 1989) repors over 150 insances relaed o he purpose of environmenal improvemen in 14 OECD counries. However, many axes and charges adoped parly for environmenal reasons were mainly for he purpose of raising revenues. Oher surveys show a rising rend in he use of EIs in developed counries. OECD (1994) repors he number of EIs increased almos 50 percen jus from 1987 o Covering he years , OECD (1999b) shows ha all of he OECD Member counries ha responded o he quesionnaire (24 ou of 29) are using some ypes of EIs. However, he populariy of EIs among developed counries ofen blurs he rue naure of environmenal insrumens: many environmenal axes iled emission charges or fees usually are no exacly Pigouvian axes. As Fulleron, e al (2001) emphasize, mos charges on various polluans are no Pigouvian axes, no maer wha hey are called. Difficulies in precisely monioring he levels of polluans force many developed counries o use less-ambiious charges or axes on he bases ha are easier o observe and enforce (OECD, 1999a). The siuaions in developing counries are no much differen and migh be worse. 7 Technological consrains such as he use of daed echnologies are mixed wih srucural consrains such as large numbers of small polluers ha are hard o regulae, large radiional secors, high bureaucraic cos, corrupion, lack of poliical will, and severe shorage of budge and manpower. All hese facors make i more difficul o implemen EIs successfully. In China, for example, emission fees are charged on 20 7 In addiion o he difficulies wih monioring and enforcemen of effecive environmenal policy insrumens, many developing counries have disinc srucural characerisics differen from developed counries. They are ofen characerized by a large share of agriculure in oal oupu and employmen, and by large share of informal (or non-axable) economic aciviies (Tanzi and Zee, 2000). Due o hese consrains, many developing counries have relied heavily on indirec consumpion axes such as sales or excise axes. This paper akes advanage of he fac ha a uniform consumpion ax on marke oupu is equivalen o a uniform ax on marke labor. 6 differen air polluans. However, firms are required o pay fees only for he wors case polluan, even when more han one polluan exceeds he permissible level. Oher polluans face no charge a he margin. 8 Worsening hese problems is ha fees reduce firms ax liabiliies, and ha 80 percen of fees are evenually reurned o hese firms. These problems cause perverse incenives for firms o perpeuae noncompliance (Blackman and Harringon, 2000) LITERATURE REVIEW Though he lieraure on environmenal axes is vas, i usually assumes ha emissions can be perfecly observable, or ha a ax on he consumpion good or a ax on a marke inpu corresponds exacly o a ax on emissions. An early example is Sandmo (1975). He examines he opimal ax rae when he aggregae amoun of one of he consumpion goods eners he uiliy funcion direcly as a negaive exernaliy. Thus, he assumes ha he relaion beween he oupu and he exernaliy is fixed, where only changes in oupu level can reduce he emissions level. In his case, a ax on emissions is equivalen o a ax on he oupu of he polluing indusry. Cremer and Gahvari (2001) re-examine he resuls of Sandmo in he case where axaion of a consumpion good is no equivalen o a ax on emissions. In a second-bes world wih disoring labor axes, hey show ha axes on emissions and on 8 Furhermore, acual monioring of emissions is based only on visual inspecion of he clariy of flue gases. Acual fees are deermined in combinaion wih esimaes of emissions volumes, bu many sudies poin ou ha he emissions fees are well below marginal abaemen coss for mos firms and hus provide limied abaemen incenives (ang, e al, 1997). 9 In order o solve adminisraive difficulies in implemening an emissions ax, developing counries ofen rely on oher policy insrumens: produc axes on fuels in many counries, volunary agreemens and informaion disclosure such as he Clean River Program in Indonesia (O Connor, 1998). However, he overall evaluaion of experiences wih EIs in many developing counries indicaes ha EIs have poenially increased
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