On the Choice of Tax Base to Reduce Greenhouse Gas Emissions in the Context of Electricity Generation

This paper analyses the role of uncertain demand in determining the government’s choice

between an ad valorem and a specific base for its tax to reduce greenhouse gas emissions

in the electricity generating sector. Using a model of optimal capacity choice for a pricetaking

firm facing demand uncertainty it is shown that an ad valorem tax is more effective

in reducing emissions than its equivalent specific tax, although this benefit comes at the

cost of lower reliability of electricity supply. A numerical analysis provides a robust

finding that the ad valorem tax is expected to generate greater tax revenue, thereby

providing support for the choice of this tax base in situations where the extra tax revenue

can be used to compensate consumers for reduced reliability of supply.