Regulation Versus Taxation

Abstract

We study which policy tool and at what level would be chosen by majority voting to reduce negative externalities, such as pollution. We consider three instruments: a rule, that sets an upper limit to the polluting activity, a quota that obliges to proportional reduction, and a tax on the activity. For all instruments the majority chooses too restrictive levels when pollution is mainly due to a small fraction of the population, and when costs for reducing activities or paying taxes are convex, and vice versa. Even though a tax is in general superior to the other two instruments, the majority may strategically choose a rule in order to charge the minority a larger share of the cost for the externality reduction.

Keywords: Externalities, Voting, Rules, Taxation

JEL Classification: D62, D72, D78, H23