Efficient environmental policy with imperfect compliance

Discussions of efficient environmental policy tend to recommend taxes rather than quotas on grounds of efficiency; a uniform tax will equalize marginal abatement cost between polluters. When polluters' actions are imperfectly observable, the distinction between taxes and quotas becomes less clear. Taxes may be evaded by underreporting of emissions, while quota violations will not always be discovered. This paper explores the conditions under which the efficiency properties of taxes continue to hold even when evasion is possible, and the extent to which the fine for quota violations plays the same role as a tax on emissions with similar efficiency properties.