Optimal Policies for Decarbonization via Carbon Capture: Tax, Subsidize, or Both?

This study examines how governments can design decarbonization policies using emission taxes, carbon capture and storage (CCS) subsidies, or a combination of both. We develop a two-stage model in which the government first chooses policy instruments to maximize welfare, while carbon-intensive firms respond by selecting production and abatement levels. We then use Monte Carlo simulations to assess how simultaneous variation in model parameters affects optimal policies. The analytical results reveal that taxes and subsidies are strategic substitutes raising one calls for reducing the other. The optimal policy mix depends on pollution intensity and damage. High intensity favors a tax-only policy regime, while low intensity calls for subsidies alone or a mix of both, based on marginal damage. These results highlight the need for policymakers to condition policy instruments on environmental parameters. The simulation results reveal the emergence of a tax-only regime where tax rates are tightly anchored to marginal damages.