Carbon abatement in the fuel market with biofuels: Implications for second best policies

Christine Lasco Crago, Madhu Khanna

Research output: Contribution to journalArticlepeer-review


A carbon tax on fuel would penalize carbon intensive fuels like gasoline and shift fuel consumption to less carbon intensive alternatives like biofuels. Since biofuel production competes for land with agricultural production, a carbon tax could increase land rents and raise food prices. This paper analyzes the welfare effect of a carbon tax on fuel consisting of gasoline and biofuel in the presence of a labor tax, with and without a biofuel subsidy. The market impacts of a carbon tax are also compared with that of a subsidy. Findings show that if a carbon tax increases biofuel demand, the tax interaction effect due to higher fuel prices is exacerbated by higher land rent and food prices and greater erosion of the carbon tax base. Thus, the second best optimal carbon tax for fuel is lower with biofuel in the fuel mix, especially if biofuel is subsidized.

Original languageEnglish (US)
Pages (from-to)89-103
Number of pages15
JournalJournal of Environmental Economics and Management
Issue number2
StatePublished - Mar 2014


  • Biofuel
  • Carbon tax
  • Optimal fuel tax
  • Second best policy

ASJC Scopus subject areas

  • Economics and Econometrics
  • Management, Monitoring, Policy and Law

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