What is the Optimal Offsets Discount under a Second-Best Cap & Trade Policy?
AbstractDespite concerns about additionality, leakage, permanence, and verification, carbon offsets have been proposed as a core component of recent cap-and-trade proposals in order to contain costs, involve uncapped sectors in GHG reduction goals, and build mitigation capacity in developing countries. Discounting the value of offsets relative to GHG allowances (i.e., setting a trading ratio less than one) has been suggested as one approach to protect the integrity of the cap. This paper presents a simple theoretical model to derive the optimal trading ratio between offsets and allowances when coverage of emissions by the cap-and-trade and offsets programs is incomplete. I discuss the relationship between the trading ratio and the GHG cap and offsets baseline, which jointly determine the stringency of the policy. While a discount for leakage is always optimal, one notable result is that if “hot air” is introduced by setting either the baseline cap or the cap too leniently, an extra discount is warranted.
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Bibliographic InfoPaper provided by National Center for Environmental Economics, U.S. Environmental Protection Agency in its series NCEE Working Paper Series with number 201204.
Length: 27 pages
Date of creation: Jul 2012
Date of revision: Jul 2012
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offsets; additionality; leakage; baseline; cap and trade; second-best theory;
Find related papers by JEL classification:
- D62 - Microeconomics - - Welfare Economics - - - Externalities
- H23 - Public Economics - - Taxation, Subsidies, and Revenue - - - Externalities; Redistributive Effects; Environmental Taxes and Subsidies
- Q54 - Agricultural and Natural Resource Economics; Environmental and Ecological Economics - - Environmental Economics - - - Climate; Natural Disasters
- Q58 - Agricultural and Natural Resource Economics; Environmental and Ecological Economics - - Environmental Economics - - - Environmental Economics: Government Policy
This paper has been announced in the following NEP Reports:
- NEP-ALL-2012-07-14 (All new papers)
- NEP-ENE-2012-07-14 (Energy Economics)
- NEP-ENV-2012-07-14 (Environmental Economics)
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