The Efficiency and Robustness of Allowance Banking in the U.S. Acid Rain Program

This paper provides an empirical evaluation of the efficiency of allowance banking in the nationwide market for sulfur dioxide (SO2) emission allowances that was created by the U.S. Acid Rain Program. We develop a model of efficient banking, select appropriate parameter values, and evaluate the efficiency of observed temporal pattern of abatement based on aggregate data from the first eight years of the Acid Rain Program. Contrary to the general opinion that banking in this program has been excessive, we find that it has been reasonably efficient. We also identify the erroneous assumptions underlying the earlier view and the conditions required for efficient banking to exist independently of changes in the counterfactual, an attribute we call robustness. These results show that firms use banking provisions in a rational and predictable way and that, at least in the US Acid Rain Program, there is no support for the often expressed concern that banked permits will be used all at once to create emissions spikes.