Taxes vs Permits: Options for Price-Based Climate Change Regulation

This paper provides an overview of key issues involved in the choice among market-based instruments for climate change policy. Specifically, it examines the potential net benefits from shifting to a permit system for emission reduction, and the preconditions necessary for this change. It also draws out the implications of New Zealand’s specific circumstances and current climate policies for future policy development.climate change; emissions trading; permits; taxation; New Zealand

Politics and Economics of Second-Best Regulation of Greenhouse Gases: The Importance of Regulatory Credibility

Modellers have examined a wide array of ideal-world scenarios for regulation of greenhouse gases. In this ideal world, all countries limit emissions from all economic sectors; regulations are implemented by intelligent, well-informed forward-looking agents; all abatement options, such as new energy technologies and forestry offsets, are available; trade in goods, services and emission credits is free and unfettered. Here we systematically explore more plausible second-best worlds. While analysts have given inordinate attention to which countries participate in regulation—what we call “variable geometry”—which has a strikingly small impact on total world cost of carbon regulations if international trade in emission credits allows economies to equilibrate. Limits on emission trading raise those costs, but by a much smaller amount than expected because even modest amounts of emission trading (less than 15% of abatement in a plausible scenario that varies the geometry of effort) have a large cost-reducing impact. Second best scenarios that see one sector regulated more aggressively and rapidly than others do not impose much extra burden when compared with optimal all-sector scenarios provided that regulations begin in the power sector. Indeed, some forms of trade regulation might decrease the financial flows associated to a carbon policy thus increasing political feasibility of the climate agreement. Much more important than variable geometry, trading and sectors is another factor that analysts have largely ignored: credibility. In the real world governments find it difficult to craft and implement credible international regulations and thus agents are unable to be so forward-looking as assumed in ideal-world modelling exercises. As credibility declines the cost of coordinated international regulation skyrockets—even in developing countries that are likely to delay their adoption of binding limits on emissions. Because international institutions such as treaties are usually weak, governments must rely on their own actions to boost regulatory credibility—for example, governments might “pre-commit” international regulations into domestic law before international negotiations are finally settled, thus boosting credibility. In our scenarios, China alone would be a net beneficiary of pre-commitment that advances its carbon limits two decades (from 2030, in our scenario, to today) if doing so would make international regulations more credible and thus encourage Chinese firms to invest with a clearer eye to the future. Overall, low credibility is up to 6 times more important in driving higher world costs for carbon regulations when compared with variable geometry, limits on emission trading and variable sectors. In this paper, we have not explored the other major dimension to the second-best: the lack of timely availability of the full range of abatement options, although our results suggest that even this will be less consequential than credibility.Greenhouse Gases, Second-best Regulation

International environment agreements and the case of global warming

First, this article uses standard welfare economics to illustrate the market failure and policy coordination problems caused by transboundary pollution problems in general and global warming in particular. Secondly, a brief overview is given of the main results obtained by empirical modelling exercises that combine both cost and damage estimates for global warming. Thirdly, the theoretical conclusions are confronted with the reality of ongoing international climate negotiations and the 1997 Kyoto Protocol is evaluated from an economic point of view. Finally, some recommendations are made for the design of future climate agreements.global warming, externalities, international environmental agreements, Nash equilibrium, cost efficiency, participation constraints, equity, Kyoto Protocol

Fairness, Credibility and Effectiveness in the Copenhagen Accord: An Economic Assessment

State-of-the-art literature on climate change policies has proposed numerous approaches for the Post-Kyoto agreement. However, in analysing the outcome of negotiations, the feeling is that a huge gap exists between policy makers and scientists. This paper tries to bridge this gap by providing a critical and comparative analysis of the Copenhagen Accord provisions, linking them to a part of the climate-economy literature. It assesses Copenhagen outcome in terms of economic efficiency, environmental effectiveness and political credibility. Our conclusion suggests that the Copenhagen Accord succeeded in considering some of the climate policy principles, namely credibility, equity and fairness. First, the change in political leadership indicates a more collaborative mood. Regarding equity and fairness, developing countries obtained an explicit commitment by developed countries for technology, but especially financial transfers, though on a conditional basis. The major limitation of the Accord is the way it addresses the trade-off between politically viability, thus implicitly fairness, and economic and environmental effectiveness. Therefore, future negotiations should deal with the eventuality of a global temperature increase above the 2 degrees, even in the presence of successful global mitigation.International Climate Policy Architecture, Integrated Assessment Model, Post-Kyoto

The European Carbon Market in Action: Lessons from the First Trading Period Interim Report

Abstract and PDF report are also available on the MIT Joint Program on the Science and Policy of Global Change website (http://globalchange.mit.edu/).The European Union Emissions Trading Scheme (EU ETS) is the largest greenhouse gas market ever established. The European Union is leading the world's first effort to mobilize market forces to tackle climate change. A precise analysis of the EU ETS's performance is essential to its success, as well as to that of future trading programs. The research program "The European Carbon Market in Action: Lessons from the First Trading Period," aims to provide such an analysis. It was launched at the end of 2006 by an international team led by Frank Convery, Christian De Perthuis and Denny Ellerman. This interim report presents the researchers' findings to date. It was prepared after the research program's second workshop, held in Washington DC in January 2008. The first workshop was held in Paris in April 2007. Two additional workshops will be held in Prague in June 2008 and in Paris in September 2008. The researchers' complete analysis will be published at the beginning of 2009.The research program “The European Carbon Market in Action: Lessons from the First Trading Period” has been made possible thanks to the support of: Doris Duke Charitable Foundation, BlueNext, EDF, Euronext, Orbeo, Suez, Total, Veolia

Radiative Forcing: Climate Policy to Break the Logjam in Environmental Law

This article recommends the key design elements of US climate law. Much past environmental law has suffered from four design problems: fragmentation, insensitivity to tradeoffs, rigid prescriptive commands, and mismatched scale. These are problems with the design of regulatory systems, not a rejection of the overall objective of environmental law to protect ecosystems and human health. These four design defects raised the costs, reduced the benefits, and increased the countervailing risks of many past environmental laws. The principal environmental laws successfully enacted since the 1990s, such as the acid rain trading program in the 1990 Clean Air Act (CAA) Amendments and the 1996 Safe Drinking Water Act amendments, were consciously designed to overcome the prior design defects. New law for climate change should improve on the design of past environmental law, fostering four counterpart solutions to the prior design defects: cross-cutting integration instead of fragmentation, attention to tradeoffs instead of their neglect, flexible incentive-based policy instruments such as emissions trading in place of rigid prescriptive commands, and optimal instead of mismatched scale. This article advocates a design for U.S. climate policy that embodies these four design solutions. It proposes a policy that is comprehensive in its coverage of multiple pollutants (all GHGs), their sources and sinks; multiple sectors (indeed economy-wide); and multiple issues currently divided among separate agencies. It advocates explicit attention to tradeoffs, both benefit-cost and risk-risk (including both ancillary harms and ancillary benefits), in setting the goals and boundaries of climate policy. It advocates the use of flexible market-based incentives through an efficient cap-and-trade system, with most allowances auctioned along multi-year emissions reduction schedules that are reviewed periodically in light of new information. And it advocates matching the legal regime to the environmental and economic scale of the climate problem, starting at the global level, engaging all the major emitting countries (including the U.S. and China), and then implementing at the national and sub-national levels rather than a patchwork bottom-up approach. In so doing it addresses the roles of EPA regulation under the current CAA and of new legislation. It argues that among environmental issues, climate change is ideally suited to adopt these improved policy design features

U.S. Greenhouse Gas Cap-and-Trade Proposals: Application of a Forward-Looking Computable General Equilibrium Model

Abstract in HTML and technical report in PDF available on the Massachusetts Institute of Technology Joint Program on the Science and Policy of Global Change website (http://mit.edu/globalchange/www/).We develop a forward-looking version of the MIT Emissions Prediction and Policy Analysis (EPPA) model, and apply it to examine the economic implications of proposals in the U.S. Congress to limit greenhouse gas (GHG) emissions. We find that the abatement path and CO2-equivalent (CO2-e) price in the forward-looking model are quite similar to that of the recursive model, implying that the simulation of banking behavior in the recursive model by forcing the CO2-e price to rise at the discount rate approximates fairly well the banking result obtained with the forward-looking model. We find, however, that shocks in consumption path are smoothed out in the forward-looking model and that the lifetime welfare cost of GHG policy is lower than in the recursive model, results we would expect to find given that the forward-looking model can fully optimize over time. The forward-looking model allows us to explore issues for which it is uniquely well-suited, including revenue-recycling, early action crediting, and the role of a technology backstop. We find (1) capital tax recycling to be more welfare-cost reducing than labor tax recycling because of its long term effect on economic growth, (2) potentially substantial incentives for early action credits relative to emission levels in years after a policy is announced but before it is implemented that, however, when spread over the full horizon of the policy do not have a substantial effect on lifetime welfare cost or the CO2-e price, and (3) strong effects on estimates of near-term welfare costs depending on exactly how a backstop technology is represented, indicating the problematic aspects of focusing on short-term welfare costs in a forward-looking model unless there is some confidence that the backstop technology is realistically represented.This study received support from the MIT Joint Program on the Science and Policy of Global Change, which is funded by a consortium of government, industry and foundation sponsors

The Economics of Climate Policy

Economics has played an increasingly important role in shaping policy, in the United States and elsewhere. This paper reviews some of the dimensions of the economic approach to analyzing, understanding, and developing solutions to the problem of climate change. We then turn to the issue of designing regulatory instruments to control the problem. The paper concludes with a discussion of the political economy of greenhouse gas control in an international context.climate change, climate policy design, integrated assessment, environmental policy coordination

A Review of Emission Trading Systems

This paper serves as a review of emission trading systems as a means to achieve reductions in the level of greenhouse gas emissions and other pollutants around the world. The review begins with the history of emission trading, beginning with early theoretical frameworks developed by economists in the 1960s and 1970s, followed by early implementations of permit markets similar to modern day emission trading systems. International negotiations related to emission reductions such as the Kyoto Protocol and Paris Agreement are discussed. Next, the economic mechanisms of emission trading systems are discussed, including a brief comparison to carbon taxes as an alternative market based implement to enact emission reductions. Finally, primary failures of emission trading systems are presented, showcasing some of the downfalls of such systems. The conclusion of this paper is that while emission trading systems provide a means to achieve a specified level of emission reductions at minimal cost, their dependence on the target level of reductions defines their effectiveness at reducing emissions. While not guaranteed to effectively reduce emissions, emission trading systems remain a powerful administrative tool to reduce the burden of cost when faced with meeting emission targets

Life After Kyoto: Alternative Approaches to Global Warming

This study reviews different approaches to the political and economic control of global public goods like global warming. It compares quantity-oriented control mechanisms like the Kyoto Protocol with price-type control mechanisms such as internationally harmonized carbon taxes. The pros and cons of the two approaches are compared, focusing on such issues as performance under conditions of uncertainty, volatility of the induced carbon prices, the excess burden of taxation and regulation, potential for corruption and accounting finagling, and ease of implementation. It concludes that, although virtually all discussions about economic global public goods have analyzed quantitative approaches, price-type approaches are likely to be more effective and more efficient.