This paper analyzes the effects of environmental policy on employment (and unemployment) using a new general-equilibrium two-sector search model. We find that imposing a pollution tax causes substantial reductions in employment in the regulated (polluting) industry, but this is offset by increased employment in the unregulated (nonpolluting) sector. As a result, while the policy causes a substantial shift in employment between industries, the net effect on overall employment (and unemployment) is small, even in the short run. An environmental performance standard causes a substantially smaller sectoral shift in employment than the emissions tax, with roughly similar net effects. Thus, policymakers who want to minimize sectoral shifts in employment might prefer performance standards over environmental taxes. The effects on the unregulated industry suggest that empirical studies of environmental regulation that focus only on regulated firms can be misleading, significantly overstating the net employment effects (and those that use nonregulated firms as controls for regulated firms will be even more misleading, overstating both the net effects and effects on the regulated industry). This implies that overall effects on employment are less of an issue for environmental policy than the empirical literature might suggest.
- Imposing a pollution tax leads to substantial reductions in employment in the polluting sector of the economy, but those losses are offset by an employment increase of similar magnitude in nonpolluting sectors.
- Because of this offsetting effect on the nonpolluting (unregulated) industry, empirical studies that focus only on regulated firms can be misleading. And those that use nonregulated firms as controls for regulated firms will be even more misleading.
- A modest economy-wide carbon tax would likely cause a substantial shift in employment between industries, but would have little overall effect on unemployment, even in the short run.
- The magnitude of employment shifts between industry sectors is much smaller under a performance standard (a constraint on pollution emissions per unit of output) than under a pollution tax, but the overall effect on employment is similar.
- To the extent that policymakers want to minimize sectoral shifts in employment, performance standards (and related intensity-standard policies) may be attractive policy options.