The Regulatory Choice of Noncompliance in Emissions Trading Programs

Abstract

This paper addresses the following question: To achieve a fixed aggregate emissions target cost-effectively, should emissions trading programs be designed and implemented to achieve full compliance, or does allowing a certain amount of noncompliance reduce the costs of reaching the emissions target? The total costs of achieving the target consist of aggregate abatement costs, monitoring costs, and the expected costs of collecting penalties from noncompliant firms. Under common assumptions, I show that allowing noncompliance is cost-effective only if violations are enforced with an increasing marginal penalty. However, one can design a policy that induces full compliance with a constant marginal penalty that meets the aggregate emissions target with lower expected costs. This last result does not depend on setting an arbitrarily high constant marginal penalty. In fact, the marginal penalty need not be higher than the equilibrium marginal penalty under the policy with the increasing marginal penalty, and can actually be lower. Finally, tying the marginal penalty directly to the permit price allows the policy objective to be achieved without any knowledge of firms' abatement costs.

Environmental Policy Instruments: Technology Adoption Incentives with Imperfect Compliance

“…This means that we can ensure a positive permit holding unless the marginal fine when no permits are held (i.e., the maximum marginal fine) is smaller than the permit price. 11 See, among others, Malik (1990), Keeler (1991), Stranlund and Dhanda (1999) and Stranlund (2007). Also, these results have been recently tested experimentally, see Murphy and Stranlund (2006).…”

“…The different studies analyze the static efficiency properties of marketable emission permits, pollution taxes, abatement subsidies and/or pollution standards under different alternatives of the monitoring and sanctioning policies. Some of these studies look at firms' incentives to abate pollution under given policy instruments with the possibility of non-compliance (such as Downing and Watson 1974;Harford 1978;Malik 1990or Keeler 1991, while others determine optimal policies under imperfect compliance (such as Jones 1989;Stranlund and Dhanda 1999;Montero 2002;Sadmo 2002;MachoStadler and Perez-Castrillo 2006;Stranlund 2007;Arguedas 2008 or Rousseau and Proost 2009). 1 However, none of these studies analyze the dynamic properties of these instruments with imperfect compliance, that is, firms' incentives to adopt new abatement technologies.…”

“…Nevertheless, asRequate (2005) has pointed out, this terminological distinction is not always sharp in the literature, sinceDowning and White (1986) talk about innovation, whereasMilliman and Prince (1989) use the notion of technical change, although the real subject of both studies is the incentive for adopting a (cleaner) existing technology. 4 As inRequate and Unold (2001) orStranlund (2007), our model does not deal with imperfect competition either in the output or the permits market, which allows us to focus on how the existence of imperfect compliance affects the incentives to adopt cleaner technologies in the benchmark-perfect competition-framework. This implies a setting where firms may differ with respect to both abatement and investment costs, but whose size in terms of output production and emission levels is small, resulting in a price taking behavior in both markets.…”

The Cost-Effective Choice of Policy Instruments to Cap Aggregate Emissions with Costly Enforcement

“…They either assume that perfect compliance is the regulator's objective, as in Malik (1992) and Chávez et al (2009), or that it is simply non-attainable, as in Hahn and Axtell (1995). Stranlund (2007) seems to be the first to have addressed the issue of whether the regulator can use non-compliance as a way to reduce the costs of a program that caps aggregate emissions. To put it clearly, the question he addresses is the following: if a regulator wants to achieve a certain level of aggregate emissions from a set of firms at the least possible cost using tradable permits, must the regulator design a program that allows a certain level of non-compliance or must the program be enforced perfectly?…”

“…Considering the total costs of the program (abatement, monitoring, and sanctioning), we then characterize the total cost-effective design of an emission standards system and compare it to the costs of an optimally designed transferable emissions permit system, as in Stranlund (2007), under different assumptions of the penalty structure.…”