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Abstract
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.