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The Effect of Allowance Allocations on Cap-and-Trade System Performance

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  • Hahn, Robert W.
  • Stavins, Robert Norman

Abstract

We examine an implication of the “Coase Theorem†which has had an important impact both on environmental economics and on public policy in the environmental domain. Under certain conditions, the market equilibrium in a cap-and-trade system will be cost-effective and independent of the initial allocation of tradable rights. That is, the overall cost of achieving a given aggregate emission reduction will be minimized, and the final allocation of permits will be independent of the initial allocation. We call this the independence property. This property is very important because it allows equity and efficiency concerns to be separated in a relatively straightforward manner. In particular, the property means that the government can establish the overall pollution-reduction goal for a cap-and-trade system by setting the cap, and leave it up to the legislature – such as the U.S. Congress – to construct a constituency in support of the program by allocating the allowances to various interests without affecting either the environmental performance of the system or its aggregate social costs. Our primary objective in this paper is to examine the conditions under which the independence property is likely to hold – both in theory and in practice. A number of factors can call the independence property into question theoretically, including market power, transaction costs, non-cost-minimizing behavior, and conditional allowance allocations. We find that, in practice, there is support for the independence property in some, but not all cap-and-trade applications.

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Bibliographic Info

Paper provided by Harvard Kennedy School of Government in its series Scholarly Articles with number 4449098.

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Date of creation: 2010
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Publication status: Published in HKS Faculty Research Working Paper Series
Handle: RePEc:hrv:hksfac:4449098

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  1. > Environmental and Natural Resource Economics > Climate economics > Policy instruments
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Cited by:
  1. Chan, Gabriel & Stavins, Robert & Stowe, Robert & Sweeney, Richard, 2012. "The SO2 Allowance Trading System and the Clean Air Act Amendments of 1990: Reflections on Twenty Years of Policy Innovation," Working Paper Series rwp12-003, Harvard University, John F. Kennedy School of Government.
  2. Pahle, Michael & Fan, Lin & Schill, Wolf-Peter, 2011. "How emission certificate allocations distort fossil investments: The German example," Energy Policy, Elsevier, vol. 39(4), pages 1975-1987, April.
  3. Sebastian Goers & Alexander Wagner & Jürgen Wegmayr, 2010. "New and old market-based instruments for climate change policy," Environmental Economics and Policy Studies, Society for Environmental Economics and Policy Studies - SEEPS, vol. 12(1), pages 1-30, June.
  4. Miola, A. & Marra, M. & Ciuffo, B., 2011. "Designing a climate change policy for the international maritime transport sector: Market-based measures and technological options for global and regional policy actions," Energy Policy, Elsevier, vol. 39(9), pages 5490-5498, September.

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