Time Inconsistency in Environmental Policy: Tax Earmarking as a Commitment Solution

Tax earmarking imposes a constraint on government policymaking, and may be desirable if it solves a time‐inconsistency problem in tax policy. In a two‐period economy, in which the policy decisions regarding taxes, public goods provision, and pollution abatement are taken by a majority‐elected individual, we show how the time‐inconsistency problem in environmental policy arises. We demonstrate that the commitment equilibrium under no earmarking rules cannot be as fully implemented as a no‐commitment equilibrium under earmarking rules. However, the earmarking rules do act as a partial commitment mechanism.