Are "efficient" climate policy instruments efficient?

Bengt Johansson, Lund University

Keywords

emission trading, carbon taxes, regulation, energy efficiency, industry

Abstract

General economic policy instruments have the potential for providing efficient emission reduction as they equalise marginal costs for emission reduction among different actors. They also give incentives for various responses such as energy efficiency improvements, fuel substitution and reduced consumption of carbon intensive products which is something that will also enhance efficiency. However, as a result of the fact that it has so far been impossible to implement instruments on a global scale, the instruments are often adapted in such a way that some of the potential advantages of the instruments are eliminated. One example is the widespread use of tax reductions for energy intensive industries.

In this paper the possibilities for different policy instruments to contribute to CO2 emission reductions while preserving the competitiveness for industry is evaluated theoretically. The focus of the analysis is on carbon taxes, emission trading based on different allocation alternatives, and regulation. Carbon taxes without tax reductions and emission trading with allocation through auctioning would have theoretical advantages in a global climate regime but may provide significant disadvantages if implemented in a single or small groups of countries. Emission trading with free intensity-based allocation would have a major advantage as it would combine incentives for emission reductions through efficiency improvements and fuel substitution while giving little support for production reductions. The negative effect is that such a system will give little incentive for reducing the consumption of carbon intensive products. The paper ends with a discussion of different ways to handle this problem.