Tax versus emissions trading scheme in the long run

In this paper we compare the performance of emission taxes and tradable permits under free market entry when firms face idiosyncratic ex ante cost uncertainty. We show that under auctioned permits insufficient entry occurs, while under a linear emission tax scheme, depending on parameters, market entry can be either excessive or insufficient. Our long-run analysis thus contrasts with Spulber׳s (1985) equivalence result and also modifies Weitzman׳s result in favor of an ETS in that the superiority of a tax over an ETS is not guaranteed, even when the Weitzman condition favors a tax. We also show that an ETS is superior to a tax scheme when the entry cost is low and the magnitude of uncertainty/asymmetric information and the size of the output market are large.     

Incentives and prices in an emissions trading scheme with updating

Emissions trading schemes where allocations are based on updated baseline emissions give firms less incentive to reduce emissions for a given quota (or allowance) price. Nevertheless, according to Böhringer and Lange [On the design of optimal grandfathering schemes for emission allowances, Europ. Econ. Rev. 49 (2005) 2041–2055], such allocation schemes are cost-effective if the system is closed and allocation rules are identical across firms. In this paper, we show that the cost-effective solution may be infeasible if marginal abatement costs grow too fast. Moreover, if a price cap or banking/borrowing is introduced, the abatement profile is no longer the same as in the case with an auction (or lump-sum allocation). In addition, we show that with allocation based on updated emissions, the quota price will always exceed marginal abatement costs, possibly misguiding policy makers and investors about abatement costs. Numerical simulations indicate that the quota price most likely will be several times higher than marginal abatement costs, unless a significant share of allowances is auctioned.