March 6, 2011

The Effect of Allowing Pollution Offsets With Imperfect Enforcement

by Hilary Sigman and Howard F. Chang

- Public policies for pollution control, including climate change policies, sometimes allow polluters in one sector subject to an emissions cap to offset excessive emissions in that sector with pollution abatement in another sector. The government may often find it more costly to verify offset claims than to verify compliance with emissions caps. Concerns about such difficulties in enforcement may lead regulators to restrict the use of offsets. In this paper, we demonstrate that allowing offsets may increase pollution abatement and reduce illegal pollution, even if the government has a fixed enforcement budget. We explore the circumstances that may make allowing pollution offsets an attractive option when enforcement is costly.

Sigman, H. and H.F. Chang (2011). "The Effect of Allowing Pollution Offsets With Imperfect Enforcement." NBER Working Paper No. 16860, Mar 2011.

Pigou Meets Mirrlees: On the Irrelevance of Tax Distortions for the Second-Best Pigouvian Tax

by Bas Jacobs and Ruud A. de Mooij

- This paper extends the Mirrlees (1971) model of optimal income redistribution with optimal corrective taxes to internalize consumption externalities. It is demonstrated that the optimal second-best tax on an externality-generating good should not be corrected for the marginal cost of public funds. The reason is that the marginal cost of public funds equals unity in the optimal tax system, since marginal distortions of taxation are equal to marginal distributional gains. The Pigouvian tax needs to be modified, however, if polluting commodities or environmental quality are more complementary to leisure than non-polluting commodities are.

Jacobs, B. and R.A. de Mooij (2011). "Pigou Meets Mirrlees: On the Irrelevance of Tax Distortions for the Second-Best Pigouvian Tax." CESifo Working Paper No. 3342, Feb 2011.

Optimal Carbon Tax with a Dirty Backstop - Oil, Coal, or Renewables?

by Frederick van der Ploeg and Cees Withagen

- Optimal climate policy is studied. Coal, the abundant resource, contributes more CO2 per unit of energy than the exhaustible resource, oil. We characterize the optimal sequencing oil and coal and departures from the Herfindahl rule. "Preference reversal" can take place. If coal is very dirty compared to oil, there is no simultaneous use. Else, the optimal outcome starts with oil, before using oil and coal together, and finally coal on its own. The "laissez-faire" outcome uses coal forever or starts with oil until it is no longer profitable to do so and then switches to coal. The optimum requires a steeply rising CO2 tax during the oil-only phase and a less steeply rising CO2 tax during the subsequent oil-coal and coal-only phases to avoid the abrupt switch from oil to coal thus leaving a lot of oil in situ.

van der Ploeg, F. and C. Withagen (2011). "Optimal Carbon Tax with a Dirty Backstop - Oil, Coal, or Renewables?" CESifo Working Paper No. 3334, Jan 2011.

Public Investment as Commitment

by Reyer Gerlagh and Matti Liski

- Should public assets such as infrastructure, education, and the environment earn the same return as private investments? The long-term nature of public investments provides commitment to current preferences, which justifies lower than private returns for time-inconsistent decision markers. An institutionalized (i.e., exogenous) rule demanding equalized comparable returns removes the bias and implements the standard cost-benefit requirement. We show that such a stand-alone rule has no general welfare content: it implements Pareto efficiency if and only if preferences are time-consistent. Efficiency requires rules not only for the composition of investments but also for overall savings. Without supplementary rules for savings, accepting lower returns for long-term public assets is welfare improving.

Gerlagh, R. and M. Liski (2011). "Public Investment as Commitment." CESifo Working Paper No. 3330, Jan 2011.

Adaptation, Mitigation and Risk-Taking in Climate Policy

by Heike Auerswald, Kai A. Konrad and Marcel Thum

- In contrast to the existing literature, we explicitly model the decision of risk-averse governments on mitigation and adaptation policies. Furthermore we also consider the interaction of the two strategies. Mitigation efforts of a single country trigger crowding out as other countries will reduce their mitigation efforts. We show that, under fairly mild conditions, a unilateral increase in mitigation efforts of a single country can even increase global emissions. In contrast, a unilateral commitment to large adaptation efforts benefits the single country and may reduce the global risk from climate change at the expense of other countries.

Auerswald, H., K.A. Konrad and M. Thum (2011). "Adaptation, Mitigation and Risk-Taking in Climate Policy." CESifo Working Paper No. 3320, Jan 2011.

Efficiency, Productivity and Environmental Policy: A Case Study of Power Generation in the EU

by Jurate Jaraite and Corrado Di Maria

- This study uses the EU public power generating sector as a case study to investigate the environmental efficiency and productivity enhancing performance of the European Union’s CO2 Emissions Trading Scheme (EU ETS) in its pilot phase. Using Data Envelopment Analysis methods, we measure the environmental efficiency and the productivity growth registered in public power generation across the EU over the 1996-2007 period. In the second stage of our analysis we attempt to explain changes in productivity and efficiency over time using state-of-the-art econometric techniques.

Jaraite, J. and C. Di Maria (2011). "Efficiency, Productivity and Environmental Policy: A Case Study of Power Generation in the EU." FEEM Note di lavoro No. 2011.019, Feb 2011.

Energy and Climate Change in China

by Carlo Carraro and Emanuele Massetti

- The paper examines future energy and emissions scenarios in China, presenting historical data and scenarios generated using the Integrated Assessment Model WITCH. A Business-as-Usual scenario is compared with four scenarios in which Greenhouse Gases emissions are taxed, at different levels. Key insights are provided to evaluate the Chinese pledge to reduce the emissions intensity of Gross Domestic Product by 40/45 percent in 2020 contained in the Copenhagen Accord. Marginal and total abatement costs are discussed using the OECD economies as a term of comparison. Cost estimates for different emissions reduction targets are used to assess the political feasibility of the 50 percent global reduction target set by the G8 and Major Economies Forum in July 2009.

Carraro, C. and E. Massetti (2011). "Energy and Climate Change in China." FEEM Note di lavoro No. 2011.016, Feb 2011.

Optimal Emission Policy under the Risk of Irreversible Pollution

by Alain Ayong Le Kama, Aude Pommeret and Fabien Prieur

- We consider an optimal consumption and pollution problem that has two important features. Environmental damages due to economic activities may be irreversible and the level at which the degradation becomes irreversible is unknown. Particular attention is paid to the situation where agents are relatively impatient and/or do not care a lot about the environment and/or Nature regenerates at low rate. We show that the optimal policy of the uncertain problem drives the economy in the long run toward a steady state while, when ignoring irreversibility, the economy follows a balanced growth path accompanied by a perpetual decrease in environmental quality and consumption, both asymptotically converging toward zero.

Le Kama, A.A., A. Pommeret and F. Prieur (2011). "Optimal Emission Policy under the Risk of Irreversible Pollution." FEEM Note di lavoro No. 2011.014, Feb 2011.

The Impact of Border Carbon Adjustments under Alternative Producer Responses

by N. Winchester

- Border carbon adjustments (BCAs) have been proposed to address leakage and competitiveness concerns. In traditional assessments, firms regard BCAs as output taxes rather than implicit emissions taxes. Using a stylized energy-economic model, we analyze the impact of BCAs for alternative producer responses. When firms view BCAs as an implicit emissions tax, the outcome depends on whether or not firms can differentiate production across destination markets. If firms are able to produce a low-emissions variety for regions imposing BCAs, results are similar to when firms regard BCAs as an output tax. If firms produce a single variety for all markets, BCAs result in larger leakage reductions than in standard approaches. We also find that BCAs are less effective at addressing competitive concerns in scenarios that result in larger leakage reductions.

Winchester, N. (2011). "The Impact of Border Carbon Adjustments under Alternative Producer Responses." MIT Joint Program Report Series, Report No. 192, Feb 2011.

General Equilibrium, Electricity Generation Technologies and the Cost of Carbon Abatement

by Lanz, B., and S. Rausch

- Electricity generation is a major contributor to carbon dioxide emissions, and a key determinant of abatement costs. Ex-ante assessments of carbon policies mainly rely on either of two modeling paradigms: (i) partial equilibrium models of the electricity sector that use bottom-up engineering data on generation technology costs, and (ii) multi-sector general equilibrium models that represent economic activities with smooth top-down aggregate production functions. In this paper, we examine the structural assumptions of these numerical techniques using a suite of models sharing common technological features and calibrated to the same benchmark data.

Lanz, B., and S. Rausch (2011). "General Equilibrium, Electricity Generation Technologies and the Cost of Carbon Abatement." MIT Joint Program Report Series, Report No. 194, Feb 2011.

California Industry Impacts of a Statewide Carbon Pricing Policy with Output-Based Rebates

by Richard D. Morgenstern and Eric Moore

- This study estimates the impacts on a disaggregated set of California industries of introducing a carbon pricing policy within the state. Two time horizons are considered, the "very short run" and the "short run". To limit adverse impacts on the state’s energy-intensive and trade-exposed (EITE) industries, we develop illustrative policy options involving free allowance allocations of emissions permits to particular industries and limited border adjustments on coal, natural gas, crude oil, and refined petroleum product imports, as well as on electricity. Overall, we find relatively small impacts on energy-intensive industries with the rebates in place. The average reduction in EITE output is 0.4 percent.

Morgenstern, R.D. and E. Moore (2011). "California Industry Impacts of a Statewide Carbon Pricing Policy with Output-Based Rebates." RFF Discussion Paper 11-05, Feb 2011.

Options for Returning the Value of CO2 Emissions Allowances to Households

by Dallas Burtraw and Ian W.H. Parry

- This paper examines alternative ways that the value of CO2 emissions allowances created under cap-and-trade policy could be returned to households. One approach (based on principles of economic efficiency) is effectively a “tax shift” that would use revenues from an auction of CO2 emissions allowances to reduce preexisting distortionary taxes. A second approach (based on principles of property rights for common-pool resources), known as cap-and-dividend, would refund allowance value as equal lump-sum cash transfers to households. Economic theory suggests (with some caveats) that a tax shift would be considerably less costly to the overall economy. In contrast, cap-and-dividend provides ample compensation for low-income households, though it appears to be more costly than other approaches, including perhaps well-designed regulatory policies. A dividend approach might be combined with other policies to provide incentives for households to invest in energy-efficient technologies and thereby lower the costs of the carbon policy.

Burtraw, D. and I.W.H. Parry (2011). "Options for Returning the Value of CO2 Emissions Allowances to Households." RFF Discussion Paper 11-03, Feb 2011.