In this paper we compare an emissions tax and an emissions standard when the firm and regulator bargain over the stringency of proposed regulations. Unlike other models, we allow the firm a choice of technologies with which to abate the externality. The technologies differ in terms of the trade-offs they embody between fixed and marginal costs of abatement. There is a "clean" technology that has higher fixed costs, but lower marginal abatement costs, than another "dirty technology."

With either technology, the regulator must incur enforcement costs to ensure the firm's compliance with a policy instrument. These enforcement costs are lower with the clean technology. The firm naturally ignores these enforcement costs when choosing a technology and may opt to choose the dirty technology even though the clean one is socially preferable because of its lower enforcement costs. In this case, an incentive to bargain exists: the regulator can offer the firm a less stringent regulation (e.g., a lower tax) in return for the firm adopting the clean technology. In engaging in such bargaining the regulator trades off lower enforcement costs against higher environmental damages.

We assess the relative merits of a tax and a standard in this setting using a Nash bargaining framework. The threat points for the bargaining games are given by the equilibria of the corresponding noncooperative Stackelberg games, hence, the threat points are endogenous.

Despite our symmetric information setting, we find that the bargaining outcomes obtained with a tax and a standard generally differ. We characterize the conditions under which a tax dominates a standard in terms of minimizing social costs. We find that whether the tax is dominant depends on the nature of the threat point (noncooperative equilibrium) and on the magnitude of the savings in enforcement costs associated with the clean technology. If enforcement costs are sufficiently small, a standard always dominates a tax.