OECD Taxation Working Papers

2223-5558 (online)
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Working papers from the Centre for Tax Policy and Administration of the OECD that cover the full range of the Centre’s work on taxation with the main focus on tax policy related issues.

Permit allocation rules and investment incentives in emissions trading systems You or your institution have access to this content

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Florens Flues1, Kurt van Dender1
Author Affiliations
  • 1: OECD, France

15 Nov 2017
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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.
technology neutrality, average carbon prices, permit allocation, California Cap and Trade Program, carbon pricing, emissions trading systems, benchmarks, EU ETS, decarbonisation
JEL Classification:
  • D04: Microeconomics / General / Microeconomic Policy: Formulation, Implementation, and Evaluation
  • D25: Microeconomics / Production and Organizations / Intertemporal Firm Choice: Investment, Capacity, and Financing
  • D47: Microeconomics / Market Structure, Pricing, and Design / Market Design
  • H23: Public Economics / Taxation, Subsidies, and Revenue / Taxation and Subsidies: Externalities; Redistributive Effects; Environmental Taxes and Subsidies
  • H32: Public Economics / Fiscal Policies and Behavior of Economic Agents / Fiscal Policies and Behavior of Economic Agents: Firm
  • L51: Industrial Organization / Regulation and Industrial Policy / Economics of Regulation
  • Q48: Agricultural and Natural Resource Economics; Environmental and Ecological Economics / Energy / Energy: Government Policy
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