Setting the Tax

As one might suspect, this is a very contentious part of the process with many different interest groups arguing over who should shoulder the tax and what the appropriate tax rate is. Rationally speaking, the tax should be set at the marginal abatement cost (MAC) that is the same across the relevant industry, commercial sector etc. This realizes the desired, optimal pollution reduction. When it is set at this point, individual firms have no incentive to continue polluting, as the marginal cost of the tax would be higher than the marginal benefit of the added production. Likewise, there's no incentive to abate past this point, as the marginal cost of abatement would be higher than the tax. From an industry-wide perspective, the setting of the tax where the marginal cost of abatement is the same for all firms is the most cost-effective solution. It might require more concessions from a low abatement-cost firm and less reductions from a high abatement-cost firm, which might conflict with one's concept of equity. Yet, this saves much more money than an across the board emission rate or required pollution control regulations.

Political Considerations

As with all policy, politics are always involved. This applies especially when it comes to levying taxes, and particularly when those taxes are for significant business interests like oil and international airlines. So the optimal tax point where MAC is equalized across the industry is rarely reached. Companies and other groups with divergent interests may engage in rent-seeking in the formulation of the tax code and formulation.This outsider input might even be so self-serving as to contain fraudulent information.The conflicting views from powerful interests make it hard for a policy-maker to formulate and pass the most efficient tax legislation.

In addition, there are large information problems with setting the tax which are addressed further on.

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