Emission tax vs. permit trading under bounded rationality and dynamic markets

Joël Foramitti*, Ivan Savin, Jeroen C.J.M. van den Bergh

*Corresponding author for this work

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Abstract

A price on emissions can be achieved through an emission tax or permit trading. The advantages and drawbacks of either instrument are debated. We present an agent-based model to compare their performance under bounded rationality and dynamic markets. It describes firms that face uncertainty about future demand and prices; use heuristic rules to decide production levels, trading prices, and technology adoption; and are heterogeneous in terms of production factors, abatement costs, and trading behavior. Using multiple evaluation criteria and a wide range of parameter values, we find that the main difference between the two policies lies in the fact that permit prices fall after successful abatement. This can lead to higher production levels under permit trading, but can also drive emission-efficient firms out of the market. Scarcity rents under permit trading can further create higher profit rates for firms, the extent of which is shown to depend on the mechanisms for market-clearing and initial allocation.

Original languageEnglish
Article number112009
Pages (from-to)1-14
Number of pages14
JournalEnergy Policy
Volume148
Issue numberPart B
Early online date12 Nov 2020
DOIs
Publication statusPublished - Jan 2021

Funding

This study has received funding through an ERC Advanced Grant from the European Research Council (ERC) under the European Union's Horizon 2020 research and innovation programme (grant agreement n°741087 ). I.S. acknowledges financial support from the Russian Science Foundation [RSF grant number 19-18-00262 ].

FundersFunder number
Horizon 2020 Framework Programme
European Research Council
Russian Science Foundation19-18-00262
Horizon 2020741087

    Keywords

    • Abatement
    • Agent-based Modeling
    • Carbon Tax
    • Climate Policy
    • Emission trading

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