Secondary materials, Pigouvian taxes, and a monopsony

TL;DR

This paper explores how secondary materials and Pigouvian taxes interact in pollution control, showing subsidies for secondary materials can replace taxes only under restrictive conditions, and extends the analysis to a monopsony setting with residual heat.

Contribution

It introduces a model where subsidizing secondary materials can replace Pigouvian taxes and extends the framework to a monopsony market for residual heat.

Findings

Secondary materials can replace Pigouvian taxes only under unrealistic price conditions.

A combined subsidy-tax policy is socially optimal and budget-neutral.

The monopsony model shows how subsidies and taxes align firm incentives with social goals.

Abstract

Secondary materials present promising opportunities for firms to repurpose emissions into marketable goods, aligning with circular economy principles. This paper examines conditions under which introducing a market for secondary materials can completely replace Pigouvian emissions taxes. These conditions prove highly restrictive: positive Pigouvian emissions taxes remain necessary unless secondary materials prices immediately reach unrealistically high levels. We propose that the socially optimal budget-neutral policy is to subsidize secondary materials prices while taxing uncontrolled emissions. Further, we extend the analysis to a two-firm framework where a data center supplies residual heat to a district heating firm acting as a monopsony buyer. This extension explicitly models the demand for residual heat and explores how subsidies and emissions taxes align firm incentives with the social optimum in the absence of competitive markets.