The design of second best forest incentives in small open economies

In this article, we examine the design and choice of forest incentives under second best conditions. The government faces constraints on uses of funds, the government has decided to use a subsidy system despite the welfare costs that exist with these programs, and the government has different preferences for landowner income, nontimber benefits production, and revenue generation. In particular, we examine how government preferences affect the decision to use harvest tax exemptions and the decision to subsidize expansion of the forest tax base through forest conversion. A new approach to studying forest incentive design is proposed where the government is treated as the decision maker and chooses policies to maximize welfare of the forest sector subject to its revenue constraint. This approach allows investigation of efficient reform in an existing forest subsidy system. For an empirical application of the model, we use data from Chile's forest sector to determine short-run dead weight losses of existing subsidies as a basis for reform recommendations. The basic approach in the article should be useful in predicting the behavior of revenue constrained governments.