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Permit allocation rules and investment incentives in emissions trading systems

Author

Listed:
  • Florens Flues

    (OECD)

  • Kurt van Dender

    (OECD)

Abstract

This paper argues that, in situations where choices are made between mutually exclusive investment projects and where there are economic rents, free allocation of tradable emission permits in emissions trading systems can weaken incentives for firms to invest in less carbon-intensive technologies compared to the case where permits would be auctioned. The reason is that permit allocation rules affect economic rents differentially when different product benchmarks apply to products that are close substitutes. Examples of permit allocation rules favouring more emission-intensive technologies for outputs that are close substitutes are found in the California Cap and Trade Program and in the European Union Emissions Trading System. This lack of technology-neutrality is exacerbated in the long run as future patterns of substitutability between technologies are uncertain. Free permit allocation can broaden support for carbon pricing, but this paper shows that this carries a cost in terms of environmental effectiveness if it discourages investment in low-carbon assets.

Suggested Citation

  • Florens Flues & Kurt van Dender, 2017. "Permit allocation rules and investment incentives in emissions trading systems," OECD Taxation Working Papers 33, OECD Publishing.
    • Handle: RePEc:oec:ctpaaa:33-en
    DOI: 10.1787/c3acf05e-en
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    Citations

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    Cited by:

    1. Filippo Maria D'Arcangelo & Marzio Galeotti, 2022. "Environmental Policy and Investment Location: The Risk of Carbon Leakage in the EU ETS," Working Papers 2022.27, Fondazione Eni Enrico Mattei.
    2. D'Arcangelo, Maria Filippo & Galeotti, Marzio, 2022. "Environmental Policy and Investment Location: The Risk of Carbon Leakage in the EU ETS," FEEM Working Papers 327158, Fondazione Eni Enrico Mattei (FEEM).
    3. Simone Borghesi & Chiara Franco & Giovanni Marin, 2020. "Outward Foreign Direct Investment Patterns of Italian Firms in the European Union's Emission Trading Scheme," Scandinavian Journal of Economics, Wiley Blackwell, vol. 122(1), pages 219-256, January.
    4. Teixidó, Jordi & Verde, Stefano F. & Nicolli, Francesco, 2019. "The impact of the EU Emissions Trading System on low-carbon technological change: The empirical evidence," Ecological Economics, Elsevier, vol. 164(C), pages 1-1.

    More about this item

    Keywords

    average carbon prices; benchmarks; California Cap and Trade Program; carbon pricing; decarbonisation; emissions trading systems; EU ETS; permit allocation; technology neutrality;
    All these keywords.

    JEL classification:

    • D04 - Microeconomics - - General - - - Microeconomic Policy: Formulation; Implementation; Evaluation
    • D25 - Microeconomics - - Production and Organizations - - - Intertemporal Firm Choice: Investment, Capacity, and Financing
    • D47 - Microeconomics - - Market Structure, Pricing, and Design - - - Market Design
    • H23 - Public Economics - - Taxation, Subsidies, and Revenue - - - Externalities; Redistributive Effects; Environmental Taxes and Subsidies
    • H32 - Public Economics - - Fiscal Policies and Behavior of Economic Agents - - - Firm
    • L51 - Industrial Organization - - Regulation and Industrial Policy - - - Economics of Regulation
    • Q48 - Agricultural and Natural Resource Economics; Environmental and Ecological Economics - - Energy - - - Government Policy

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