Research Paper on Prices and Taxes under Heterogeneous Beliefs and Ambiguity in a Ramsey Climate Policy Model

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Title: Prices and Taxes under Heterogeneous Beliefs and Ambiguity in a Ramsey Climate Policy Model

Abstract: In a Ramsey policy regime, it is demonstrated that heterogeneity in beliefs regarding the potential costs of climate change generates policy ambiguities that alter carbon prices and taxation. Considered are three sources of ambiguity: I the private sector is skeptical, with beliefs unknown to the government; (ii) private agents have pessimistic doubts about the model; and (iii) the policy authority does not trust the existing scientific climate model and fears the worst. These three sources of ambiguity give rise to four potential belief regimes characterized by differences between the government’s and the private sector’s inter-temporal substitution rates, with implications for the prices of carbon and capital, framed in terms of a distorted Arrow–Debreu pricing theory that establishes an equivalence between the optimal carbon tax and the permit price of an underlying asset—the government-imposed limit on emissions in economies with a carbon tax. This paper demonstrates that in the majority of cases, skepticism and the resulting ambiguity justify higher carbon taxes and lower capital taxes to compensate for the private sector’s increased myopia relative to rational expectations. In contrast, ambiguities created by worst-case fears in either the private or public sector tend to generate opposing forces.

Keywords: Knightian uncertainty; multiplier preferences; Ramsey planner; social planner; carbon tax; capital tax; ambiguity premium; dynamic stochastic integrated general equilibrium (DSIGE); robust Arrow–Debreu asset prices

Paper Quality: SCOPUS / Web of Science Level Research Paper

Subject: Economics

Writer Experience: 20+ Years

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