Prices versus Quantities in a Second-Best Setting

The choice between taxes and tradable permits has been independently analysed by two distinct research traditions. The first proceeds from Weitzman's partial equilibrium stochastic model and concludes that a tax should be preferred if the marginal abatement cost curve is steeper than the marginal environmental benefit curve. The second utilises deterministic general equilibrium models with pre-existing distortionary taxes. It concludes that non-revenue-raising instruments (e.g., grandfathered tradable permits) are costlier than revenue-raising ones (e.g., a tax on every unit of pollution or auctioned permits). To build a bridge between these two traditions, we introduce in Weitzman's model a positive cost of public funds due to pre-existing distortionary taxes. The tax admits a greater comparative advantage over the permits, as compared to Weitzman's classical result. Then, we assume that the regulated industry blocks any proposal that poses it too high an expected burden. This may require a transfer to firms, in the form of freely-allocated permits or lump-sum tax rebate. It turns out that if this acceptability constraint is binding, then the comparative advantage of taxes over permits is still reinforced. Quantitatively, even if the marginal benefit function is 50% more steeply sloped than the marginal cost function, the price instrument should be preferred. We also compare the expected net benefit of these two instruments to a contingent instrument which leads to the ex post optimum. The superiority of the contingent instrument over the quantity one is higher than in first-best.     

Pollution Permits: A Discussion of Fundamentals

The author provides an economic analysis of tradable pollution permits by clarifying the derivation of permit supply and demand relationships and connecting those concepts to permit trading for the case of two polluters. Using the standard comparison of costs and benefits, he makes the marginal cost of emission reduction of a typical polluter the basis of the derivation of its permit supply and demand schedules. Developing these relationships for both polluters allows the creation of market schedules for permit supply and demand. He demonstrates equilibrium in the market for permits and the corresponding trading of permits. He discusses the satisfaction of the equi-marginal principle, which ensures that pollution reduction is achieved efficiently. The author concludes by considering the consequences of the presence of a third polluter in the market for permits.     

妨碍我国排污权交易政策实施的制度瓶颈分析

结合污染物的总量控制和排污许可证制度,我国已经进行了十多年的各类排污权交易试点工作。但是,排污权交易却至今未能形成一个全国统一的环境政策。本文利用制度分析框架从制度结构与不完全合约的角度对此进行分析,并认为妨碍我国排污权交易政策实施的制度瓶颈主要是排污权交易制度结构的缺陷。     

Prices versus quantities: environmental regulation and imperfect competition

By exercising market power, a firm will distort the production, and therefore the emissions decisions, of all firms in the market. This paper examines how the welfare implications of strategic behavior depend on how pollution is regulated. Under an emissions tax, aggregate emissions do not affect the marginal cost of polluting. In contrast, the price of tradable permits is endogenous. I show when this feedback effect increases strategic firms’ output. Relative to a tax, tradable permits may improve welfare in a market with imperfect competition. As an application, I model strategic and competitive behavior of wholesalers in a Mid-Atlantic electricity market. Simulations suggest that exercising market power decreased emissions locally, thereby substantially reducing the regional tradable permit price. Furthermore, I find that had regulators opted to use a tax instead of permits, the deadweight loss from imperfect competition would have been even greater.     

Technology Diffusion with Market Power in the Upstream Industry

This paper compares taxes and tradable permits when used to regulate a competitive and polluting downstream industry that can purchase an abatement technology from a monopolistic upstream industry. Second-best policies are derived for the full range of the abatement technology’s emission intensities and marginal abatement costs. The second-best permit quantity can be both above or below the socially optimal emission level. Explicit consideration of the output market provides further insights on how market power distorts the allocation in the downstream industry. The ranking between permits and taxes is ambiguous in general, but taxes weakly dominate permits if full diffusion is socially optimal. In addition, it is analysed how a cap on the permit price affects the diffusion of an abatement technology.     

Conserving biodiversity with tradable permits under changing conservation costs and habitat restoration time lags

Tradable permits are a common environmental policy instrument that has recently been applied also to the conservation of biodiversity. Biodiversity conservation differs in many respects to the classical applications of tradable permits like emissions control. One particularity is that, even if the permit system maintains a constant total amount of species habitat, habitat turnover (the destruction of a habitat and restoration elsewhere) affects the ecosystem. Another particularity is that the restoration of habitats often takes much time, leading to time lags between the initiation of restoration activities and the time when restored habitat is available for trading. We use an agent-based model of a tradable permit market to study the influence of heterogeneous and dynamic conservation costs and habitat restoration time lags on key variables of the market, such as the costs incurred to the market participants and the amount of habitat turnover. Our results show that there may be trade-offs between these key variables. We also find that restoration time lags can lead to fluctuations in permit prices that reduce the efficiency of the permit market. We conclude that temporal lags deserve a careful analysis when implementing tradable permit systems for the preservation of natural habitats and biodiversity.     

Allocating Tradable Permits on the Basis of Market Price to Achieve Cost Effectiveness

It is a well known result that distributional constraints can lead to an imperfectly competitive permit market where the emission target is no longer met at least cost. In this paper, we suggest an allocation rule for tradable permits which can handle this problem. If the permit allocation is dependent on the market price for permits, this allocation rule can achieve both cost effectiveness and meet specific requirements for cost distribution across agents.     

Intertemporal Emission Permits Trading Under Uncertainty and Irreversibility

This paper analyzes the effect of emission permit banking on clean technology investment and abatement under conditions where the stringency of the future cap is uncertain. We examine the problem of heterogeneous firms minimizing the cost of intertemporal emission control in the presence of stochastic future pollution standards and emission permits that are tradable across firms and through time. A firm can invest in clean capital (an improved pollution abatement technology) to reduce its abatement cost. We consider two possibilities: that investment is reversible or irreversible. Uncertainty is captured within a two period model: only the current period cap is known. We show that if banking is positive and marginal abatement costs are sufficiently convex, there will be more abatement and investment in clean technology under uncertainty than there would be under certainty and no banking. These results are at odds with the common belief that uncertainty on future environmental policy is a barrier to investment in clean capital. Moreover, under uncertainty and irreversibility, we find that there are cases where banking enables firms to invest more in clean capital.     

Managing Permit Markets to Stabilize Prices

The political economy of environmental policy favors the use of quantity-based instruments over price-based instruments (e.g., tradable permits over green taxes), at least in the United States. With cost uncertainty, however, there are clear efficiency advantages to prices in cases where the marginal damages of emissions are relatively flat, such as with greenhouse gases. The question arises, therefore, of whether one can design flexible quantity policies that mimic the behavior of price policies, namely stable permit prices and abatement costs. We explore a number of “quantity-plus” policies that replicate the behavior of a price policy through rules that adjust the effective permit cap for unexpectedly low or high costs. They do so without necessitating any monetary exchanges between the government and the regulated firms, which can be a significant political barrier to the use of price instruments.     

Transactions Costs in Tradable Permit Markets: An Experimental Study of Pollution Market Designs

Regulators' choices of market rules and permit allocations influence tradable emission permit programs. This paper uses laboratory experiments to study how transaction costs interact with permit allocations to determine the cost-effectiveness of emissions abatement. With positive transaction costs, in theory the initial distribution of permits can affect both abatement costs and equity. Consistent with theory, we find that with declining marginal transaction costs prices deviate less from the efficient level if the misallocation of the initial permit distribution is greater, and the deviation from efficient prices does not vary with the initial permit endowment when marginal transaction costs are constant.     

Allocation of emission permits with leakage through capital markets

This paper analyses how tradable emission permits should be allocated to firms when capital is internationally mobile. When international environmental problems are attempted solved through uncoordinated policies between countries, it might be desirable for the home country to issue free emission permits in proportion to the use of capital in order to prevent leakage through international capital movements. The desirability of free emission permits will however be reduced if capital also can be employed in a domestic non-polluting sector. In this case, it may even be optimal to tax the use of capital in the polluting sector. It is also shown that it is always optimal to subsidise the use of capital in the polluting sector if the use of labour is taxed at an optimal rate. Finally, leakage does not affect the optimal domestic emission limit as long as appropriate capital subsidies and labour taxes are implementeed.     

Irreversible abatement investment under cost uncertainties: tradable emission permits and emissions charges

A major concern with tradable emission permits is that stochastic permit prices may reduce a firm’s incentive to invest in abatement capital or technologies relative to other policies such as a fixed emissions charge. However, under efficient permit trading, the permit price uncertainty is caused by abatement cost uncertainties which affect investment under both permit and charge policies. We develop a rational expectations general equilibrium model of permit trading and irreversible abatement investment to show how cost uncertainties affect investment under permits. We compare the resulting investment incentive with that under charges. After controlling for the assumption that random shocks affect the abatement cost linearly, we find that firms’ investment incentive decreases in cost uncertainties, but more so under emissions charges than under permits. Therefore, tradable permits in fact may help maintain firms’ investment incentive under uncertainty.     

Choosing the right instrument

This paper analyses the optimal choice of second-best optimal environmental policies. Using a partial equilibrium model, the paper first reconfirms the well-known result that the existence of a double dividend (in its weak definition) favours environmental policy instruments which maximise tax revenues for a given improvement in environmental quality. Additional revenues can be used to reduce the distortion of existing taxes such as taxes on labour and capital income. Without uncertainty, environmental taxes and auctioned permits are equally appropriate. In the presence of uncertainty, however, the optimal choice of taxes or tradable permits depends on the relative magnitudes of the marginal environmental damage and the marginal benefit from consuming a polluting good. In the second part, the paper, therefore, analyses how the revenue capacity affects the optimal choice of environmental policy instruments in the presence of uncertainty. The paper shows that the first-best choice rule between price and quantity regulation (Weitzman, 1974) remains valid in a second-best world with distortionary taxation.     

Multi-Sector Model of Tradable Emission Permits

This paper presents a multi-sector model of tradable emission permits, which includes oligopolistic and perfectly competitive industries. The firms in oligopolistic industries are assumed to exercise market power in the tradable permit market as well as in the product market. Specifically, we examine the effects of the initial permit allocation on the equilibrium outcomes, focusing on the interaction among these product and permit markets. It is shown that raising the number of initial permits allocated to one firm in an oligopolistic industry increases the output produced by that firm. Under certain conditions, raising a “clean” (less-polluting) firm’s share of the initial permits can lead to reductions in both the product and permit prices. We discuss criteria for the socially optimal allocation of initial permits, considering the trade-off between production inefficiency and consumer benefit.     

Prices Versus Quantities: Technology Choice,Uncertainty and Welfare

Technological improvements have proven essential in mitigating environmental problems such as climate change, depletion of the ozone layer and acid rain. While it is well-known that price- and quantity-based regulatory instruments provide different investment levels, the effects on the choice between different technologies have received scant attention. This paper expands on the prices versus quantities literature by investigating firms’ technology choice in the face of demand and supply side uncertainty. I show that the regulator can not design tradable emissions permits and an emissions tax such that the two regimes are equivalent, even in terms of expected values. Moreover, a tax encourages the most flexible abatement technology if and only if stochastic costs and the equilibrium permit price have sufficiently strong positive covariance, compared with the variance in consumer demand for the good produced. Finally, the firms’ technology choices are socially optimal under tradable emissions permits, but not under an emissions tax.     

On the interaction between imperfect compliance and technology adoption: taxes versus tradable emissions permits

This paper analyzes the effects of the interaction between technology adoption and incomplete enforcement on the extent of violations and the rate of abatement technology adoption. We focus on price-based and quantity-based emission regulations. First, we show that in contrast to uniform taxes, under tradable emissions permits (TEPs), the fall in permit price produced by technology adoption reduces the benefits of violating the environmental regulation at the margin and leads firms to modify their compliance behavior. Moreover, when TEPs are used, the deterrent effect of the monitoring effort is reinforced by the effect that technology adoption has on the extent of violations. Second, we show that the regulator may speed up the diffusion of new technologies by increasing the stringency of the enforcement strategy in the case of TEPs while in the case of uniform taxes, the rate of adoption does not depend on the enforcement parameters.     

Markets of concentration permits: The case of manure policy

Concentration permits are regarded as an interesting policy tool for regulating emissions where, besides absolute amounts, also local concentration is important. However, effects of governance structure, trading system and possible policy interventions in the permits' allocation are not yet well analysed and understood. This paper explores in how far tradable fertilisation standards can be seen as a concentration permit trading (CPT) system which can be fine-tuned for further policy intervention. Indeed fertilisation standards such as obliged by the EU Nitrate Directive can be regarded as local nitrate emissions limits, and thus concentration permits. A multi-agent spatial allocation model is used to simulate the impact of defining the manure problem in terms of concentration permits rather than conventional emission permits. Impacts are simulated in terms of environmental performance and increased reallocation costs. The model is applied on the Flemish manure problem.     

A Pollution Offset System for Trading Non-Point Source Water Pollution Permits

Water pollution from non-point sources is a global environmental concern. Economists propose tradable permit systems as a solution, but they are difficult to implement due to the nature of non-point sources. We present a pollution offset system for trading non-point source water pollution permits. Conventional pollution offset systems suffer from thin markets and transaction costs. In this paper, we show how to overcome these problems with a centrally managed common-pool market. We define permits as allowable nitrate loading to a groundwater aquifer. This trading system utilizes estimates of potential nitrate leaching from land uses, a set of transport coefficients generated from a simulation of nitrate transport in groundwater, an online trading system, and a linear program to clear the market. We illustrate the concept using a hypothetical case study.     

Fees and the Efficiency of Tradable Permit Systems: An Experimental Approach

The paper presents the results of an economic experiment in which the effects of fees on allocative efficiency of tradable utilization permits (e.g. pollution permits) are explored. Laboratory subjects (university students) play the roles of firms whose generic product requires a specific input or permits. Scarcity is exogenously introduced by a fixed supply of tradable production permits. Three treatments are compared: No fee imposed (N); a fixed tax per permit (T); and partial retraction of permits and subsequent redistribution by auction (A). Treatments T and A represent two different ways of imposing fees, which are designed to be revenue equivalent. Our results indicate that, after controlling for deviation of permit prices from a prediction based on fundamentals, fees have an impact on distribution of permits. Interestingly, a fixed tax enhances efficiency compared to the case of no fees while retraction and reallocation by auction tends to reduce efficiency. Apparently, subjects’ decision making is affected by the imposition of fees, but how and to what extent depends on the method used.     

Excess Burden of Taxation and Environmental Policy Mix with a Consumer‐Friendly Firm

This study examines the environmental policy mix of tradable emission permits and emission taxes in a duopoly model with a consumer‐friendly firm. We analyse the interplay of the two policies and the welfare consequences in the presence of excess burden of taxation. We show that an emission tax can be redundant when both the excess burden of taxation and the degree of consumer friendliness are insignificant. However, when the excess burden of taxation is significant, tradable permits policy with tax treatment should be applied to enhance welfare in the presence of a consumer‐friendly firm. Finally, under the tax revenue‐neutral case where the excess burden of taxation does not matter, the environmental policy mix is also efficient if the degree of consumer friendliness is sufficiently high.