Does compensative subsidy alleviate pollutant emission and improve welfare under cross-industry pollution?

Abstract

This paper establishes a cross-industry pollution externality model under centralized labor union. In delineating the motivations of a benevolent government, it might be possible to tax part of the welfare gains and use the revenue to compensate the affected polluting industry for the damage costs, thereby improving welfare. We show that the magnitude of marginal pollution plays a critical role. When the marginal pollution is large, the government should tax the pollution firm to reduce the pollution. However, when the marginal pollution is small, the government should subsidize the polluted firm to increase output and enhance consumer surplus.