week 12: permit trading systems

emissions taxes

require a central public authority to establish the tax rate, monitor the performance of each polluter, and collect the taxes

permit trading system

polluters interact to buy and sell emission permits, and the authority just controls the number of permits available

offset trading

allows one party to pay another party to reduce emissions

• sellers: reduce emissions and sell the offsets to buyers

• buyers: purchase offsets to compensate for an increase in emissions

compliance offset trading markets

firms must meet statutory requirements, but may trade allowances amongst themselves to meet these requirements

voluntary offset trading markets

individuals and firms buy offsets at their own discretion

what makes a carbon offset ‘real’?

• permanent (offset cannot be temporary)

• additional (reduction would not have occurred without transaction)

• verifiable (reduction must be confirmed to have occurred)

• enforceable (reduction can only be counted once)

cap and trade system

• creates a market for allowances

• supply: cap established by authority

• demand: aggregate MAC curve of all firms participating in the program

• permit price provides the incentive for emission reductions, similar to the incentives created by an emission tax

cap and trade in 4 steps:

1. set the cap

2. allocate or auction allowances

3. firms operate and produce emissions (and buy/sell allowances)

4. at the end of each period, regulator checks that firms have enough allowances to cover emissions

independence property

process of trading permits will lead firms to allocate abatement in a cost-effective way by equating the MAC of their last unit abated to the permit price

if MAB is less elastic (steeper) than MAC…

quantity instrument is better

if MAB is more elastic (flatter) than MAC…

price instrument is better