Taxes, Trading or Both?: An Experimental Investigation of Abatement Investment under Alternative Emissions Regulation

Abstract

Emissions taxes and emissions permit trading schemes are designed to reduce greenhouse gas (GHG) emissions by providing incentives for large emitters to invest in less emissions-intensive production technologies. Whereas taxes place a fixed price on emissions, tradable permit schemes include a secondary permit market, from which allowance prices emerge after the regulation enters into force. Under a newly imposed regulation, the delay in price information contributes to uncertainty about the future cost of compliance that liable emitters will face, thereby challenging liable entities’ ability to make optimal abatement investment decisions. Using laboratory experiments, this thesis examines the effects of a policy regime that is similar to the one implemented in Australia in 2012. The regime includes a staged transition over time from a regulation-free environment, to an emissions tax and then to emissions trading. The thesis examines the effects of such a staged transition on investment decisions, the level of emissions, permit prices and trading behavior, comparing it to standard policy regimes of only an emissions tax and only emissions permit trading. The findings suggest that a regime based on a staged transition from a tax to permit trading results in lower compliance costs and higher overall allocative efficiency compared to a regime based solely on emissions trading in a market of heterogeneous producing firms.