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

53 Pages Posted: 16 Feb 2013

See all articles by Meredith Fowlie

Meredith Fowlie

University of California, Berkeley

Nicholas Z. Muller

Carnegie Mellon University - David A. Tepper School of Business

Date Written: February 2013

Abstract

Much of the air pollution currently regulated under U.S. emissions trading programs is non-uniformly mixed, meaning that health and environmental damages depend on the location and dispersion characteristics of the sources. Existing policy regimes ignore this fact. Emissions are penalized at a single permit price, regardless of the location of the source. In theory, differentiated policies can be designed to accommodate non-uniformly mixed pollution using emissions penalties that vary with emissions damages. Under perfect certainty, damage-based policy differentiation is unambiguously welfare improving. In the presence of uncertainty about damages and abatement costs, differentiated policies need not welfare dominate simpler, undifferentiated designs. Using rich data from a major U.S. emissions trading program, we estimate the welfare impacts of policy differentiation. Surprisingly, we find that differentiated emissions trading results in welfare loss as compared to the undifferentiated trading regime that was implemented. This result manifests because ex post realized abatement costs appear to have exceeded expectations. We further show that, in this context, a differentiated price-based policy welfare dominates the differentiated quantity-based alternative.

Suggested Citation

Fowlie, Meredith and Muller, Nicholas Z., Market-Based Emissions Regulation When Damages Vary Across Sources: What are the Gains from Differentiation? (February 2013). NBER Working Paper No. w18801. Available at SSRN: https://ssrn.com/abstract=2219041

Meredith Fowlie (Contact Author)

University of California, Berkeley ( email )

310 Barrows Hall
Berkeley, CA 94720
United States

Nicholas Z. Muller

Carnegie Mellon University - David A. Tepper School of Business ( email )

5000 Forbes Avenue
Pittsburgh, PA 15213-3890
United States

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