prices and quantities in a climate policy setting
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Prices and Quantities in a Climate Policy Setting Svante Mandell
Observations and aim
In practice (the EU):● Overarching quantitative target for CO2
● A dual regulation; CaT and emission taxes
Under uncertainty, emissions taxes outperform CaT for handling GHG
Q: (When) is a dual regulation justifiable?
The model
Starts in a classic Weitzman (-74) setting● Linear MAC- and MAB-functions● Uncertainty (additative, symmetric round zero)● Aggregate abatement benefits relevant
Answers if CaT or emission tax is preferable
CO2 causes a stock externality
A flat MAB
Variation in emissions ‘better’ than variation in price Use a tax
The model, cont.
Mandell (2008), JEEM:
Allow for dual regulation● Tax a subset of emitters, the rest CaT
Outcome closer to optimum, but not cost effective
Full CaT never optimal, full tax optimal for (sufficiently) flat MAB-functions
The model, cont.
This paper:● Flat (horizontal) MAB-function● A global cap that may never be exceeded● Two periods
Intuition: ● The global cap may require high tax to be met full tax
may not be optimal
Timing of the model
STAGE 0
Policy maker decides on share to tax and tax level
STAGE 1
Emitters choose emission volumes
Un
cert
ain
ty 1
is r
eso
lve
d
Po
ssib
le s
urp
lus
is b
anke
d
Un
cert
ain
ty 2
is r
eso
lve
d
STAGE 2
Emitters choose emission volumes
Ta
x le
vel m
ay
be
ch
ang
ed
Policy goal
Policy maker strives to● Minimize present value of expected efficiency loss● S.t. the global cap must not be exceeded
Thus, we need an expression for E{DWLtot}
Two sources of eff. loss
nNLN
KNNTLQNTLQKNNnNnan
LN
NLQKNfnNnNna
nNLN
KNNTLQKNNTLQanNnNnan
LN
NLQKNfnLQKNfNanNnNnaDWLE tot
6
223322
6
3322
6
3624
6
33624}{
222222
222222
211
222
222222
Volume error
Actual emissions differ from efficient amount
Allocation error
Abatement efforts not distributed in a cost effective manner
Per
iod
1P
erio
d 2
The taxes
As low as global cap permits, but never below the MAB
Less stringent global cap lower taxes
Period 1 is ”sunk” when setting T2
● T2 typically lower than T1, due to surplus
Taxes increase in share of taxed emitters
0
0,25
0,5
0,75
1
-1 -0,75 -0,5 -0,25 0 0,25 0,5 0,75 1
n* / N = 0
= 0.5
= 1
”Strict” global caps, i.e., a cap below expected efficient level
Optimal share to tax (n*)
”Lenient” global caps, i.e., a cap above expected efficient level
= discount factor
At =0 the model becomes a one-period model (outcomes in period 2 are given zero weight)
Some intuition for n*
Start in a situation where● Global cap = expected efficient level● All emitters are in CaT
At low MAC realizations – too high emissions
At high MAC realizations – too low● Thus, an expected volume error● But no allocation error
Some intuition for n* (cont.)
Move some emitters to taxed sector● At low realizations; decreased error● At highest realization; emissions equal global cap● Other high realizations; increased error● And also an allocation error
Motivates a small taxed sector
Some intuition for n* (cont.)
Now, consider a higher global cap
A larger set of realizations will yield a decrease in efficiency loss
Motivates taxing a larger share
Thus, n* increases in the global cap
The role of the discount factor
Most likely a surplus in period 1● Policy maker may not destroy permits – increased cap period 2
Lenient cap period 1 even more so period 2 risk for large efficiency loss
Stringent cap period 1 less stringent period 2 may decrease efficiency loss
The role of the discount factor
0
0,25
0,5
0,75
1
-1 -0,75 -0,5 -0,25 0 0,25 0,5 0,75 1
n* / N = 0
= 0.5
= 1
More weight on period 2 calls for a lower n* under leninet global cap…
…but a higher n* under stricter global cap
Conclusions
Often, a dual regime is better than full emissions tax or CaT
Even accounting for not cost effective
This depends on● The global cap vs. E{eff. emissions}● Indirectly the slope of the MAC vs MAB● The discount factor
Actual EU policy
Contains both crucial elements● A quantitative target and a flat MAB, but:
The ’global cap’ is not entirely fixed, e.g., CDM● Suggests the model underestimates the optimal share to tax
Trading firms may bank ’individually’● Suggests the model overestimates the optimal share to tax
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