Synergy or conflict? Assessing the combined emission reduction effects of environmental taxation and carbon trading in China's power sector

As environmental policies continue to proliferate, growing attention has turned to how one instrument may unintentionally offset or undermine the effectiveness of another. In China's power sector, for example, the Environmental Protection Tax (ET) may reduce emissions independently, but in doing so, it alters baseline conditions, depresses carbon prices, and weakens the incentive function of the Emissions Trading Scheme (ETS). This form of indirect policy interference has received limited empirical scrutiny. To address this gap, we develop a policy interaction framework to empirically assess the combined effects of ET and ETS in China's power sector. Leveraging a multi-period difference-in-differences model and variation in pilot policy implementation across provinces, we estimate the heterogeneous impacts of individual and joint policy treatments on carbon intensity. We also examine the transmission mechanism through which ET affects the carbon market by influencing allowance price dynamics. Our results show that both ETS and ET independently reduce carbon intensity, and that the effectiveness of ET increases with higher tax rates. However, when implemented concurrently, elevated tax rates suppress carbon prices and erode the market incentives intended by ETS. Mechanism analysis reveals that overlapping compliance costs can distort price signals and lead to suboptimal abatement behavior. These findings highlight a critical trade-off in hybrid environmental governance and underscore the need for better coordination between fiscal and market-based instruments to improve policy coherence and climate mitigation effectiveness, particularly in developing economies undergoing institutional transition.