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Permit allocation rules and investment incentives in emissions trading systems

Florens Flues and Kurt van Dender
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Kurt van Dender: OECD

No 33, OECD Taxation Working Papers from OECD Publishing

Abstract: This paper argues that, in situations where choices are made between mutually exclusive investment projects and where there are economic rents, free allocation of tradable emission permits in emissions trading systems can weaken incentives for firms to invest in less carbon-intensive technologies compared to the case where permits would be auctioned. The reason is that permit allocation rules affect economic rents differentially when different product benchmarks apply to products that are close substitutes. Examples of permit allocation rules favouring more emission-intensive technologies for outputs that are close substitutes are found in the California Cap and Trade Program and in the European Union Emissions Trading System. This lack of technology-neutrality is exacerbated in the long run as future patterns of substitutability between technologies are uncertain. Free permit allocation can broaden support for carbon pricing, but this paper shows that this carries a cost in terms of environmental effectiveness if it discourages investment in low-carbon assets.

Keywords: average carbon prices; benchmarks; California Cap and Trade Program; carbon pricing; decarbonisation; emissions trading systems; EU ETS; permit allocation; technology neutrality (search for similar items in EconPapers)
JEL-codes: D04 D25 D47 H23 H32 L51 Q48 (search for similar items in EconPapers)
Date: 2017-11-15
New Economics Papers: this item is included in nep-agr, nep-des, nep-ene, nep-env, nep-reg and nep-res
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