Review of Environmental Economics and Policy Advance Access first published online on January 6, 2009
This version published online on January 9, 2009
Review of Environmental Economics and Policy, doi:10.1093/reep/ren016
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© The Author 2009. Published by Oxford University Press on behalf of the Association of Environmental and Resource Economists. All rights reserved. For permissions, please email: journals.permissions@oxfordjournals.org
Balancing Cost and Emissions Certainty: An Allowance Reserve for Cap-and-Trade
* Director for Economic Analysis, Nicholas Institute, and Research Professor, Nicholas School of the Environment, Duke University.
Gendell Associate Professor of Energy and Environmental Economics, Nicholas School of the Environment, Duke University, a University Fellow at Resources for the Future, and a Research Associate at the National Bureau of Economic Research. E-mail: richard.newell@duke.edu.
Senior Fellow at Resources for the Future. Senior authorship is not assigned.
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Introduction |
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The economic debate over using taxes versus cap-and-trade to control pollution emissions revolves around the relative merits of using prices versus quantities as the policy instrument. A cap-and-trade system fixes the quantity of emissions allowed but leaves the market price of emissions rights uncertain. In contrast, a tax fixes the price of emissions at the tax rate but leaves the quantity of emissions uncertain. This trade-off raises essential questions for policy design: which form of uncertainty is a greater burden to society? What can be done to minimize that burden or maximize net benefits? A sizable economics literature has addressed these questions, dating back to Weitzman (1974) and others.
Taxes and cap-and-trade are, in some sense, extreme examples of the alternative market-based approaches that are available to correct an emissions externality. The government stipulates that emitters must obtain the "right to emit." These rights (typically called allowances or
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Market-based Emissions Regulation and the Reserve-based Approach |
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Advantages of an Allowance Reserve |
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Representing Marginal Damages across Cumulative Emissions
Expanding Political-Economic Flexibility
Addressing Concerns over Ability to Achieve Long-Term Targets
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Optimal Policy in a Dynamic Setting |
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Performance of a Tax Program
Performance of a Cap-and-Trade System
Why Dynamic Cap-and-Trade Can Deliver a Better Outcome
How Can an Allowance Reserve Enhance Efficiency?
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Implementation Issues |
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Ceiling Price and Reserve Size
Maintaining the Cumulative Cap versus Establishing a Range
Introducing Reserve Allowances to the Market
An Allowance Reserve Board or Legislative Specification?
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Conclusions |
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Technical Appendix |
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