Optimal mix of emissions taxes and cap-and-trade
In practice, different emitters of a particular pollutant are sometimes subjected to different control mechanisms. This paper focuses on the situation where a part of the economy is regulated by a cap-and-trade program, while the rest is subjected to an emissions tax. Using an extended version of Weitzman's 'Prices vs. Quantities' model [M.L. Weitzman, Prices vs. quantities, Revi. Econ. Stud. 41 (1974) 477-491], we analyze the conditions under which this is superior, from an efficiency point of view, to subjecting the whole economy to either of these control mechanisms. The paper addresses a crucial trade-off between two sources of efficiency loss, one due to cost-effectiveness issues and another due to emissions volume. This trade-off determines the optimal size of each sector. It is shown that the size of the taxed sector, at an optimum, increases with the relative steepness of the aggregate marginal abatement cost function.
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- Martin L. Weitzman, 1974.
"Prices vs. Quantities,"
Review of Economic Studies,
Oxford University Press, vol. 41(4), pages 477-491.
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- Peter Cramton & Suzi Kerr, 2002. "Tradeable Carbon Permit Auctions: How and Why to Auction Not Grandfather," Papers of Peter Cramton 02eptc, University of Maryland, Department of Economics - Peter Cramton, revised 06 May 2002.
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- Ian W. H. Parry & Roberton C. Williams III & Lawrence H. Goulder, 1997. "When Can Carbon Abatement Policies Increase Welfare? The Fundamental Role of Distorted Factor Markets," NBER Working Papers 5967, National Bureau of Economic Research, Inc.
- James M. Malcomson, 1978. "Prices vs. Quantities: A Critical Note on the Use of Approximations," Review of Economic Studies, Oxford University Press, vol. 45(1), pages 203-207.
- Weitzman, Martin L, 1978. "Optimal Rewards for Economic Regulation," American Economic Review, American Economic Association, vol. 68(4), pages 683-691, September.
- Watson, William D. & Ridker, Ronald G., 1984. "Losses from effluent taxes and quotas under uncertainty," Journal of Environmental Economics and Management, Elsevier, vol. 11(4), pages 310-326, December.
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- Jean Jacques Laffont, 1977. "More on Prices vs. Quantities," Review of Economic Studies, Oxford University Press, vol. 44(1), pages 177-182.
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