Abstract
Jurisdictions that rely on emissions trading to control emissions often utilize other environmental or energy policies as well, including policies to support renewable energy and reduce energy consumption. Overlapping policies produce economic interactions that can lead to quite different outcomes from what one might predict examining individual policies separately. Prior literature on policy interactions has primarily focused on cap-and-trade (CAT) systems, where aggregate emissions are fixed by regulation but emissions prices respond. However, jurisdictions are increasingly turning to alternative forms of emissions markets, including a range of rate-based emissions trading systems, in which both emissions quantities and prices are flexible and the significance of policy interactions is less understood.
This paper extends the literature by considering the implications under a range of ETSs—not only CAT but also several forms of tradable performance standards (TPSs)—of a variety of overlapping policies, including subsidies to renewables and taxes on electricity. An analytical model stylized on the electricity sector demonstrates that an overlapping subsidy to renewable energy drives down emission prices and expands output under all types of ETS, but emissions outcomes differ with TPSs—emissions increase with renewable subsidies under a uniform, sector-wide TPS but decrease when the TPS only covers emitters, excluding clean sources from receiving tradable credits. Taxing electricity consumption reduces emission prices and total output under all ETS types and reduces emissions under all TPSs. With CAT, adding an overlapping renewables subsidy or electricity consumption tax has efficiency costs. Under certain TPSs, however, these measures can reduce distortions and enhance cost-effectiveness.
A numerical general equilibrium model offers quantitative assessments of the impacts of overlaps on emissions, production, prices, and costs, under China’s planned ETS and alternative designs. China’s current policy overlaps reduce the cost per ton of abatement of its differentiated TPS by 20-30%; optimizing renewable portfolio standards could further reduce costs by 10%, and transitioning to uniform benchmarks for emitting power generators could save another 10-15%. Still, CAT without overlapping policies would be most cost-effective.
Overlapping renewable portfolio standards serve two goals: offsetting some distortions from differentiated benchmarks, especially those excluding renewables, and implicitly taxing electricity. Both that and indirect emissions pricing improve price pass-through in rate-based systems. Portfolio standards also achieve renewable targets in a self-adjusting manner, so as not to over-correct when changing to an ETS design that gives adequate incentives for clean producers. Our findings highlight the need to consider the choice of ETS and overlapping policies together when undertaking reforms.