The Cost-Effectiveness Implications of Carbon Price Certainty
AbstractWhile a firm knows the carbon price with certainty under a tax, it must form an expectation about future allowance prices to identify its cost-effective abatement investment under a cap-and-trade program. We illustrate graphically how errors in forming this expectation increase the costs of irreversible pollution abatement investment under cap-and-trade relative to a tax. We describe empirical "cost-effectiveness anomalies" in allowance markets that may be attributed to cap-and-trade's inherent uncertainty. We model investment under simulated US carbon tax and cap-and-trade policies and find that allowance price uncertainty can increase resource costs 20 percent for a given quantity of emission abatement.
CitationAldy, Joseph E., and Sarah Armitage. 2020. "The Cost-Effectiveness Implications of Carbon Price Certainty." AEA Papers and Proceedings, 110: 113-18. DOI: 10.1257/pandp.20201083
- D61 Allocative Efficiency; Cost-Benefit Analysis
- H23 Taxation and Subsidies: Externalities; Redistributive Effects; Environmental Taxes and Subsidies
- Q54 Climate; Natural Disasters and Their Management; Global Warming
- Q56 Environment and Development; Environment and Trade; Sustainability; Environmental Accounts and Accounting; Environmental Equity; Population Growth
- Q58 Environmental Economics: Government Policy