Market-Based Emissions Regulation When Damages Vary across Sources: What Are the Gains from Differentiation?

Meredith Fowlie and Nicholas Muller

Journal of the Association of Environmental and Resource Economists, 2019, vol. 6, issue 3, 593 - 632

Abstract: For much of the air pollution currently regulated under US emissions trading programs, health and environmental damages vary significantly with the location of the source. Existing policies do not reflect this variation. Market-based policies can be designed to accommodate nonuniformly mixed pollution by using emissions penalties that vary with damages. With perfect information and heterogeneous damages, damage-based policy differentiation is unambiguously welfare improving. In contrast, when damages and abatement costs are uncertain, differentiated policies need not welfare-dominate undifferentiated designs. Using a large-scale US emissions trading program as a case in point, we show how undifferentiated emissions trading can dominate the differentiated alternative when ex post abatement costs exceeded expectations. In contrast, under an emissions tax regime the welfare dominance of the first-best differentiated policy is robust to unanticipated cost realizations.

Date: 2019
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Working Paper: Market-based Emissions Regulation When Damages Vary Across Sources: What Are the Gains from Differentiation? (2013)
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