JOURNAL OF ENVIRONMENTAL ECONOMICS AND MANAGEMENT 10, l-17 (1983) Pollution Taxes and Standards: A Continuum of Quasi-Optimal Solutions’ J. HARFORJI Department of Economics, State University of New York at Albany, New York 12222 AND s. OGURA Department of Economics, State University of New York, Albany, New York 12222 Received July 21, 1980; revised November, 1981 A generalized second-best problem, involving a perfectly competitive industry which produces a pollution type of externality, is examined. The pollution tax is allowed to assume an arbitrary value (possibly zero), while a pollution standard, set as a ratio of pollution to output, is determined by a first-order optimizing condition. The general condition for a set of quasi-optimal solutions includes the Paretooptimal solution as a special case. It is also found that when the pollution tax is below the optimal level, the usual implication is that the standard should be set so that the marginal cost of pollution reduction exceeds the marginal external damage. 1. INTRODUCTION Economists have generally come to the conclusion that taxing pollution at a rate equal to its marginal external damage is, under perfect competition, superior in efficiency to setting a standard which limits the amount of pollution absolutely or relative to output (for example, see [2, Chap. 41). This superiority is based on the fact that a tax approach not only encourages firms to lower their pollution, but creates an additional excise tax effect that reduces consumption of the good whose produc- tion or consumption is associated with the pollution. The pollution standard alone can affect pollution directly. However, there is an absence of any charge for the external damage created by any remaining pollution. As Buchanan and Tullock, in [4] and [S], and Maler [9, p. 2181 have concluded, it is therefore necessary to restrict the output of a competitive industry as well as its pollution to hope to duplicate the results of a tax. However, restriction of output creates above normal profits in the industry and the possibility of an inefficient allocation of production among producers. Laws which authorize or dictate pollution standards, such as the Clean Air Act of 1970 [ 141 or the Federal Water Pollution Control Act Amendments of 1972 [ 151, do not, in fact, consider placing direct controls on the output of the polluting industry in the manner suggested. Moreover, one may well suspect that pollution standards ‘The authors thank Bruce Dieffenbach and anonymous referees for helpful comments on this paper. Present addresses are: J. Harford, Department of Economics, Cleveland State University, 1983 East -24th Street, Cleveland, Ohio 44115; and S. Ogura, Graduate School for Policy Science, Saitama University, Japan. 009506%/83/OKKIO1-17$3.00/O Copyright 0 1983 by Academic Press, Inc. AI1 rights of reproduction in any form reserved