The structure of the paper is as follows. Section 2 first presents the general
characteristics of the standard GEM-E3 model, and then discusses how the model is
extended to take into account a number of feedback effects of air pollution. This
extension concentrates on the health impacts of air pollution. The other effects of air
pollution that consist of effects on vegetation, materials and visibility are still taken into
account ex-post2. We incorporate the impacts of air pollution on medical spending by
the consumers and the public sector, on the available time of the consumers and on
labour productivity. Our analysis therefore considers three of the four sources of the
benefit side tax interaction effect presented by Williams (2002). We use a health
production function which relates a continuous health variable to pollution and the
consumption of medical care. This approach is most appropriate for modelling the
morbidity effects of air pollution. A realistic treatment of the mortality impacts would
require modelling health states rather than a continuous health variable (see, e.g.,
Freeman (2003)). Since it is less straightforward to integrate this in the GEM-E3
framework, this paper focuses on the morbidity effects, while the mortality impacts
continue to be modelled in the traditional way, except for the medical costs related to
them. Moreover, it is not evident to translate the total marginal willingness-to-pay for a
reduction in mortality as derived from stated preference studies in terms of
consumption, leisure and available time, as is required in our framework.
In Section 3 the standard and modified GEM-E3 model are used to simulate the
effects of a domestic CO2 tax in the EU countries. Since a CO2 policy has side effects
1 The GEM-E3 model was built under the auspices of the European Commission (DG-RES, co-ordinator
P. Valette) by a consortium involving principally NTUA, KUL, ZEW and ERASME. For a more
detailed description of the model, the reader is referred to Capros et al. (1997).
2 A more realistic modelling of the non-health related effects of air pollution in GEM-E3 is presented in
Schmidt (2000).