FEEM working papers "Note di lavoro" series
2004 .137

Cheap Talk, Gullibility, and Welfare in an Environmental Taxation Game

Authors: Christophe Deissenberg, Herbert Dawid, Pavel Ševcik
Series: Climate Change and Sustainable Development
Editor: Carlo Carraro
Type: Book
Keywords: Environmental policy,Emissions taxes,Time inconsistency,Heterogeneous agents,Bounded rationality,Learning,Multiple equilibria,Stackelberg games
JEL n.: H23,H3,Q5,C69,C79,D62
JEL: Chapter in Dynamic Games: Theory and Applications, Alain Haurie and Georges Zaccour (eds)
Published in: Springer
Date: 2005


We consider a simple dynamic model of environmental taxation that exhibits time inconsistency. There are two categories of firms, Believers, who take the tax announcements made by the Regulator to face value, and Non-Believers, who perfectly anticipate the Regulator's decisions, albeit at a cost. The proportion of Believers and Non- Believers changes over time depending on the relative profits of both groups. We show that the Regulator can use misleading tax announcements to steer the economy to an equilibrium that is Pareto superior to the solutions usually suggested in the literature. Depending upon the initial proportion of Believers, the Regulator may prefer a fast or a low speed of reaction of the firms to differences in Believers/Non-Believers profits.

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