Refunded emission payments scheme – a cost-efficient and politically acceptable instrument for reduction of NOx-emissions?

The paper studies the effectiveness of a refunded emission payments (REP) scheme in achieving a specific target path of NOx-emission reductions. A REP scheme levies a charge on emissions and refunds the collected funds back to the emitting firms. REP schemes have been highlighted as a remedy to some concerns about standard emission taxes. The purpose of a REP scheme, however, is to achieve effective emission reductions. We examine two REP designs in this paper and analyze their incentives for emission mitigation at the firm level, with heterogenous firms. In the first design, refunds are given to firms based on their emission cuts. The second design gives refunds based on output shares of the emitting firms. Results show that while both designs can achieve the specific target path, only refunding based on emission-reductions is cost-efficient. The two designs target different objectives and hence, provide different mitigation incentives, and result in different distributional outcomes. On the other hand, neither design raises governmental revenue, nor do they strictly adhere to the polluter-pays-principle. However, a REP scheme has qualities that should make it appealing to regulators, especially if an effective emission tax is unfeasible.