Early Emissions Reduction Programs: An Application to CO2 Policy

In the wake of the December 1997 Kyoto Protocol, which, if implemented, would oblige the United States and other industrialized countries to reduce greenhouse gases (GHGs) by 2008–2012, a number of proposals have been offered to increase the incentives for reducing emissions over the nearer term. The existence of an interim period between setting and implementing environmental goals is ubiquitous in environmental policymaking. The existence of this interim period gives rise to several potential rationales for early emissions reductions. In this paper we use a series of simple models and numerical illustrations to analyze some aspects of the performance of early emissions reduction programs in the case of GHGs. We show that there is a compelling economic case for allowing early GHGs reduction credits if countries (not just individual firms) could bank early credits to offset future emissions. The annualized cost savings to the United States from spreading out abatement over time could easily amount to several billion dollars. But without the aggregate banking provision, such credits could easily generate an excessive amount of abatement and produce net economic losses. We analyze a number of other issues that affect the economic efficiency of early reduction credits, including asymmetric information, learning-by-doing (LBD), and fiscal impacts. We also compare the performance of an early reduction credits program with that of an early cap-and-trade program. This latter approach, if properly scaled, can avoid many of the problems associated with early reduction credits.